• Money

Let’s say you just came up with an idea that could become a household commodity: a radical new design for a commode. We’re not just talking a variation on a theme—like adding a few extra inches  or adding a sprinkler system—but a quantum leap in how we go about our business.

Investors ought to be queuing up to get a piece of the action, right? Wrong. Professional investors want to make money—lots of it. That’s not because they’re greedy, it’s because the majority of their investments don’t work out. The National Venture Capital Association estimates that only 20 percent (or less) of venture-backed companies produce a significant return, 40 percent achieve moderate success and the rest fail.

The VC business model doesn’t work without those few big hits. For every Starbucks and Whole Foods—both VC success stories—there are four VC-backed companies you’ve probably never heard of and four you’d know only if you regularly peruse bankruptcy notices.

So from the thousands of pitches VCs receive each year, how do they decide who’s worth the risk? The pros ask themselves three questions:

Can we win?
Can you grow your company to Rs. 225 crore or Rs.450 crore in revenue in three to seven years? Is your business model scalable to achieve that kind of growth? Do you have a team of employees, advisors and others who’ve “been there, done that” and won’t be making it up as you go along? Are you qualified to lead that kind of high-performance organization?

Will we win?
Is the market big enough to support that kind of growth? Do you have a concise plan for how you’re going to reach potential customers and persuade them to… er, get off the pot? What’s going to keep Kohler and Crane from copying your idea and building it cheaper, faster or better? What might go wrong with your plan, and how are you going to deal with it? Are you willing to dramatically change your business model if that’s what it’ll take to win?

Will it be worth it?
Do you have a good understanding of your costs and capital needs? Are you offering investors a reasonable price? Can investors earn five to 10 times their investment in five to seven years through a company sale or public offering?
Even if you’re not looking for investors and your goals aren’t as lofty as theirs, you can learn from the pros. So, the next time a great idea strikes, test it with these three simple questions. The exercise may just save you from flushing your money down the drain.

KATE LISTER is a former banker, small-business investor and veteran entrepreneur. Her books and websites include Finding Money: The Small Business Guide to Financing and Undress For Success: The Naked Truth About Making Money at Home.

©Entrepreneur February 2011 by Entrepreneur Media, Inc. All rights reserved.

Tags:
business model, VC, Venture capitalists