Founders often report being frustrated by the vague criteria VCs claim to use when deciding on whether or not to invest in their startup. Investment criteria goes beyond the investment process, which we made public for Sterling Road in 2018. However, what we’re actually looking for during our process has not been previously made public. Below, we have outlined our investment criteria in detail:
Most connections we make with founders are done via email, firstname.lastname@example.org, either by introduction or direct outreach (LinkedIn is not a good way to reach out due to the spam). This initial filtering prevents wasted meetings, where the answer would be a quick “no”.
Location: We only invest in startups based in the US or Canada at present. However, this means that if you are based in Europe now but plan to launch in the US and focus on US-based customers, we may be able to work together in the future.
Solo-founder: Given the burden of building and leading a company is usually too much for one person alone, we don’t work with solo-founders.
Customer Type: We’re solely focused on B2B businesses — this is our area expertise. If you are a B2C company, there are plenty of other VCs who will be a better fit to help you distribute to consumers.
Sector: Although we do not have a specific sector focus, we tend to lean towards businesses with big markets, at least $5Bn in the US. We also tend to avoid businesses in certain sectors such as education, politics, and frontier tech, e.g. 2+ years of research & development before the product is live is not a fit for us.
Timeline: Your fundraising round’s timeline needs to fit with our 3 month process.
Terms: As a pre-seed investor, the maximum valuation we can accept is a $6M cap (ideally post-money for clarity); and given how early we invest, we also want the rights to increase our stake in the next round, up to 5%.
Tech Advantage: Usually, we’re looking for the company to have, or be building out, a clear advantage on technology that will be hard for others to replicate. We also like legacy industries with minimal technology usage, where any software might be a defensible advantage. For example, we invested in i-5O which has developed unique AI and Brainbase, which targets the antiquated intellectual property market.
During our first meeting, the goal is for both sides to understand whether it’s worth investing more time in the relationship.
Strong Team: This is the most important factor. Ideally, the team has deep expertise in their chosen field or experience as entrepreneurs in general. If not, we’re looking to quickly understand what makes you uniquely capable of building a big business in this market. For example, Pico operates in the highly competitive publishing industry but one of the founders is a bestselling author.
Willing to Engage: We take a direct approach when it comes to feedback and usually have lots of questions about a business. Most founders love this style of meeting but it’s not for everybody and that will usually become apparent in our first interactions. We’re never offended if our approach doesn’t work for you and your startup; everyone is different.
Demonstration of Demand: Ideally, the founders will have evidence that their product is both desperately needed and unique. Perhaps the best way to show this, is early traction, e.g. 5 beta users with 3 using it daily, and 15 on the waitlist.
After 3 months of working together, an investment decision is made.
Coachability: Being responsive to feedback is an essential part of leading a startup to IPO. We don’t have to agree on how to resolve each situation but you must demonstrate a willingness to listen and learn from someone, such as another advisor.
Reasoning: Rapid and high quality decision making is incredibly difficult and most founders are asked to make hard choices every week. We like to see founders break down difficult decisions to their most important components, adapt when wrong but hold firm when their plan faces expected obstacles. For example, if you set monthly goals with your team, you should have a good reason, and consensus, to throw them out after 3 days.
Resilience: Building a startup is a tumultuous roller coaster that will test even the strongest of wills. Seeing a founder handle one of the many early crises they will inevitably encounter, is a great indicator of their ability to handle similar problems as the company scales. In the early days, this characteristic often manifests as a willingness to get things done, even if sometimes tasks are boring, time consuming or emotionally difficult (e.g. laying people off).
Live with a Customer: You don’t need revenue or bookings for us to invest but your MVP should be live with at least one customer, and in use, before we invest. This both demonstrates demand (see above) and shows you can drive a customer through a basic sales funnel successfully.
Investment Committee: We ask a 3-person investment committee (all Limited Partners) for feedback on each investment. Although the committee tends to agree with my decision, they often have good questions about the market, competition and team.
Getting through all these criteria is tough, Sterling Road reviews over 1,000 startups per year to invest in around 10. If you have any feedback on this approach, please let us know!