According to a report by the tech research firm Gartner, worldwide IT spending is expected to increase by more than 5% and reach $4.6 trillion in 2023. Despite ongoing inflation in several countries, global tech is expected to perform exceedingly well over the next few years, which makes it a great time to invest in tech-based companies. However, one of the biggest problems Venture Capitalists (VCs) face while investing in tech companies is that they often don’t understand the technology well enough to make informed decisions. Not knowing about the products and services that a technology startup offers can make it difficult for VCs to gauge its performance potential.
While you aren’t expected to know every technical detail about a software product your startup offers, you should have a general idea about what the offering is and what value it can bring to customers. This will help you get a realistic idea of how much the startup is expected to spend on research and development and whether the product is worth investing in. In this article, we discuss how familiar a VC should be with the technology they’re investing in and how they can obtain all the relevant information about it.
Why is it important to invest in technology
Ever since the 2010s, tech startups have consistently received some of the highest funding from VCs. This is due to several factors. The general versatility and universal utility of technology products make it much easier for tech startups to scale quickly and start generating a positive ROI (Return on Investment). If designed well, products like Customer Relationship Management (CRM) tools or productivity enhancement solutions can help a startup find diverse clientele across several different business sectors. This allows young tech companies to expand across different market sectors and geographical demographics at reduced risk.
Further, novel ideas like Brian Chesky’s Airbnb can prove to be game changers for VC firms. Legendary angel investor and founding partner at YCombinator Paul Graham cites Airbnb as a major portfolio asset that helped the firm generate unprecedented ROI. Airbnb’s revolutionary idea - building a marketplace for short-term stays, was backed by a motivated and innovative founding team with user-friendly web and mobile applications. This helped the company garner a huge consumer base and scale quickly across several markets around the world.
While the focus now has shifted toward fintech firms (fintech venture investment grew 175% between 2020 and 2021), the principle behind Airbnb’s success story still stands. Tech companies that offer easily accessible, user-friendly solutions to everyday problems will always find sizable markets and generate impressive ROIs for VCs. Tech companies can prove to be extremely valuable portfolio assets for you if you know which ones to invest in. To make a sound, data-backed judgment on this, you need to fully grasp the technology you’re thinking of investing in, and its market potential.
How to know if you should invest in a tech company
Here are a few tips to help gauge whether or not you should invest in a tech startup and how much you should invest.
Look for a clear market problem
One of the best ways to judge whether a tech startup has any potential is to assess its product offering from a utilitarian point of view. Every successful tech product is built to meet unique consumer demand in a way that hasn’t been explored by another business before. While the solution itself doesn’t need to be novel, it should:
- Solve a real problem that affects people in their everyday lives.
- Offer unique features like affordability or a user-friendly Graphical User Interface (GUI) that other products on the market don’t currently offer.
Let’s use an illustrative example to understand the concept of a non-existing user problem. Imagine a tech startup called ABC coming up with a browser extension that can find and load pages load faster on search engines like Google and Yahoo. This is a hypothetical example of a non-existent problem because Google’s search results already load in under one-tenth of a second, or the time it takes to blink an eye. Therefore, there is no foreseeable practical need for such a product.
On the flip side, the lack of unique features in a tech product would make it vulnerable to competitive tactics such as price undercutting in what is already an incredibly cut-throat business sector. Fully understanding the need and operational utility of a tech product can help VCs make better investment decisions. These decisions should, of course, be based on thorough market research and, as far as possible, first-hand consumer feedback.
Gauge the potential for future growth
Another important factor to keep in mind while assessing a tech company is its potential for stable and sustainable future growth. While a tech startup might appear promising at the outset, its business model can lead it towards a point where its growth plateaus and market competition makes it impossible for the business to scale. For instance, while building an app for instant wine delivery within a city is a good idea, the founders need to be aware of the fact that it would be difficult for them to scale toward groceries and other e-retail products because of the presence of major players like Amazon in that space. In such a case, it would be wiser for the founders to divert their efforts and finances toward making liquor delivery faster and more customer-friendly. Finding a stable market niche is crucial for ensuring sustainable future growth for tech startups.
The future potential of a tech product also depends on the nature of the consumer demand it aims to fulfill. While some products fulfill a perennial consumer demand that leads to cyclical sales, others only serve a temporary demand which makes them more vulnerable to obsolescence once market trends change. The core idea here is that stable business growth can only be fueled by a cyclical consumer demand which keeps customers coming back, thereby generating a steady source of primary income for the startup.
Examine the data security measures
Data breaches are on the rise and novel hacking methods are making it increasingly difficult for businesses to fend off serious data security threats. Global conglomerates like Twitter and Dropbox have already become the victims of unauthorized data access in 2023. This suggests that no business, no matter how big or small, is safe from the threat of data breaches and other malicious attacks. Further, new legislation like the CCPA has made it mandatory for all digital businesses to enforce stringent data security and privacy measures. Failure to comply with these laws can invite strict disciplinary action including hefty fines and the company’s business license being revoked.
This makes it crucial for all tech startups to have apt consumer data security and privacy measures in place before they begin operations. A startup with a weak data security system is a potential investment risk that can lead to substantial financial and reputational losses for your VC firm. It is wise to always vet tech startups about their data security measures and future compliance plans before moving forward with investment negotiations.
Investing in a product you like
Apart from being aware of the technical know-how of a product, it is important to focus on its utility to the consumers. The best way to judge this is by determining if you would want to use a particular product or service for your business. You can even ask for a demo version for your firm to check how easily employees at your VC firm can onboard with the software. Doing this can help you get a better idea of the journey a customer can expect to experience when they buy the product. You can also make experience-based recommendations that will help the startup make its products more efficient and user-friendly. The ultimate goal here should be to work with the founders to craft a product that is easily accessible even to non-technical users.
We at Zapflow believe modern technology’s immense potential can be harnessed to change the way VCs operate. Zapflow is not your regular CRM, but a productivity-enhancing tool that helps VCs capture, sort, analyze, and display data in easy-to-read formats at their convenience. It can further be used to conduct thorough competitive analyses and come up with actionable insights that can help you streamline your deal flow from beginning to end. With Zapflow, you can use your business data to its maximum potential and actively derive value from it.