Understanding What Makes a Business VC-Backable

A few weeks ago, I had a blast hosting Elizabeth Yin from Hustle Fund on the podcast. One audience member asked, “How do VCs do market sizing?” While answering, Elizabeth dropped a significant insight:

“If you’re building the next CRM, you might be able to build a great company and sell it for $20 million, but VCs don’t want to touch it.”

This comment sparked a flurry of responses, DMs, and comments. The underlying question was: “What exactly is a VC-backable business?”

Today, I want to dive into that topic. Before you spend months pitching to angels and VCs, it’s crucial to understand if your business fits the bill. VC funding is tailored for specific types of businesses. If yours isn’t a fit, you can either tweak your business model to align with VC expectations or explore alternative funding sources.

The VC Business Model

To understand what makes a business VC-backable, it’s essential to grasp the VC business model and the concept of power law.

Power Law

The entire VC asset class operates on the power law principle. VCs know and expect that most of their investments will fail. They rely on a few outliers to deliver extraordinary returns—think 100x or 200x investments. These “home runs” are the fund returners.

Let’s break this down with a hypothetical scenario:

Imagine a VC fund with $100 million to invest. The fund decides to invest in 20 startups, allocating $5 million to each.

• 10 of these startups will fail completely, returning $0.
• 6 startups will do moderately well, each returning 1x their investment, or $5 million each. This brings back $30 million in total.
• 3 startups will perform very well, each returning 5x their investment, or $25 million each. This brings back $75 million in total.
• 1 startup will be a breakout success, returning 50x its investment, or $250 million.

Here’s the math:

• Total investment: $100 million
• Total returns from failed startups: $0
• Total returns from moderate successes: $30 million
• Total returns from very successful startups: $75 million
• Total returns from the breakout success: $250 million

Adding these up, the fund’s total return is $355 million on a $100 million investment, yielding a 3.55x return on the fund.

This example illustrates the power law: while most investments fail or only return a small multiple, a few outliers can provide outsized returns that make the entire fund profitable.

How VCs Make Money

VCs don’t invest their own money; they raise it from limited partners (LPs), which can include ex-founders, family offices, funds of funds, and institutional investors. These LPs expect returns higher than what they could achieve in public markets. Therefore, VCs must deliver significant returns—multiples of the invested capital.

What VCs Look For

Now that we understand the VC business model, let’s discuss the criteria that make a startup VC-backable.

Market Opportunity

VCs are looking for massive market opportunities. If your market isn’t huge (we’re talking billions), they won’t be interested. Creating yet another CRM that might get acquired for $20 million isn’t going to cut it. You need to show a clear path to capturing a significant market share within a relatively short timeframe—typically around 10 years.

Check out this article from Antler on TAM, SAM, and SOM for a deeper dive into market sizing.

Hyper-Growth Potential

It’s not enough to grow large; you need to grow large quickly. The standard venture fund has a 10-year life, with investments made in the first 3-4 years. VCs need to exit investments within 5-7 years to ensure a good ROI. Quick, significant growth is essential.

For VCs to raise subsequent funds, they need to show a track record of quick, successful exits. This requires big, fast wins to keep raising new funds and sustaining their business model.

$100+ Million Revenue

VCs are looking for businesses that can potentially generate $100+ million in revenue. Your financial projections and growth strategy should reflect this potential. It’s crucial to show how your business can scale to this level within the VC fund’s lifecycle.

Scalable, Repeatable Revenue

Your business model must generate scalable, repeatable revenue. This means having the ability to significantly increase revenue with minimal additional costs (scalable) and predictable, recurring revenue streams (repeatable). SaaS models with subscription-based revenue are prime examples.

Conversely, businesses relying on one-off sales, high human capital, or non-recurring revenue streams are less attractive to VCs.

Built for Acquisition

Most VC-backed startups aim for acquisition rather than an IPO. Your business should have a clear exit strategy, targeting acquisition by a large company. This often involves having unique intellectual property, specialized knowledge, or a strong brand.

For example, software products are typically easier to acquire once they’ve proven their value. In life sciences, pharma giants often acquire startups post-regulatory approval. However, if your business doesn’t offer something unique that a big company can’t easily replicate, it’s unlikely to attract a high acquisition premium.

Imagine a startup that invents a new adhesive. They could be an attractive target for companies like 3M or BASF, but only if the adhesive offers something truly innovative that competitors can’t easily copy. Otherwise, these large companies might simply develop a similar product internally at a lower cost.

In contrast, if a startup has developed a proprietary technology with strong patent protection or a unique brand that resonates with consumers, it becomes a more attractive acquisition target. VCs look for startups with these qualities because they increase the likelihood of a lucrative exit.

Conclusion

Building a VC-backable business isn’t about having a great product or a solid team alone. It’s about aligning with the VC model—demonstrating a huge market opportunity, hyper-growth potential, scalable and repeatable revenue, and a clear path to a lucrative exit.

If your goal is to build a sustainable, long-term business that you’ll run indefinitely, that’s fantastic. However, that’s not the venture funding model. Understanding this distinction can save you time, effort, and potential frustration in your fundraising journey.

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