How VCs Evaluate Startups: The Investment Framework
Learn how venture capitalists analyze investment opportunities. Understand the key criteria: team, market, product, traction, and unit economics.
Understanding how VCs evaluate startups is essential for VC interviews—and useful if you're ever starting a company. Here's the framework experienced investors use.
The Evaluation Framework
The 5 Key Factors
- Team – Who's building this?
- Market – How big is the opportunity?
- Product – What are they building?
- Traction – Is it working?
- Unit Economics – Can it be profitable?
The relative importance shifts by stage. Early stage emphasizes team and market; later stage emphasizes traction and unit economics.
1. Team Evaluation
What VCs Look For in Founders
| Term | Definition | Note |
|---|---|---|
| Founder-Market Fit | Why are THEY uniquely positioned to win? | Most important |
| Domain Expertise | Deep knowledge of the problem space | From experience |
| Track Record | Previous startup experience (success or learned failure) | Not required but helpful |
| Complementary Skills | Technical + business talent | Complete team |
| Grit & Resilience | Ability to persist through setbacks | Startups are hard |
| Coachability | Open to feedback and learning | Will listen to investors |
The Key Question
"Why this team?"
What unique insight, experience, or unfair advantage do these founders have? The best founders have lived the problem they're solving.
2. Market Evaluation
Market Assessment Criteria
| Term | Definition | Note |
|---|---|---|
| TAM Size | $1B+ market minimum for VC-scale returns | Bigger is better |
| Market Growth | Growing markets are easier than flat ones | Tailwinds help |
| Market Timing | Why now? What's changed? | Technology, regulation, behavior |
| Competitive Landscape | Who else is attacking this? | Crowded can be okay |
| Winner-Take-All Dynamics | Can one company dominate? | Network effects, scale |
Why Market Matters So Much
"A great team in a bad market will lose to a good team in a great market."
Even the best execution can't overcome a market that's too small, shrinking, or structurally unprofitable. Market size sets the ceiling on returns.
3. Product Evaluation
Product Assessment
| Term | Definition | Note |
|---|---|---|
| 10x Better | Product must be dramatically better, not marginally | Behavior change is hard |
| Defensibility | What prevents copying? | Network effects, IP, data |
| Product-Market Fit | Do customers love it? | Retention and NPS |
| Simplicity | Is the value proposition clear? | Easy to explain = easier to sell |
| Roadmap | Vision for future product development | Where is this going? |
Types of Defensibility (Moats)
- Network Effects: Product gets better with more users (marketplaces, social)
- Switching Costs: Painful to leave (data lock-in, integrations)
- Scale Economies: Costs decrease with size (infrastructure, distribution)
- Brand: Trust built over time (harder for startups)
- Proprietary Technology: Patents, unique IP, data advantages
4. Traction Evaluation
Traction Metrics by Type
| Term | Definition | Note |
|---|---|---|
| Revenue/ARR | Best proof of value | Customers paying |
| Growth Rate | MoM or YoY growth | >15% MoM is strong |
| User Growth | Active users, signups | Pre-revenue signal |
| Retention/Churn | Do customers stay? | Cohort analysis |
| Engagement | How often do users engage? | DAU/MAU ratio |
| NPS | Would users recommend? | >50 is excellent |
Warning
Vanity metrics vs. real metrics:
- Vanity: Total signups, page views, downloads
- Real: Active users, retention, revenue, unit economics
Focus on metrics that indicate real value delivery and sustainable growth.
5. Unit Economics Evaluation
Key Unit Economics
| Term | Definition | Note |
|---|---|---|
| LTV:CAC | Lifetime Value to Customer Acquisition Cost | >3x is good |
| Payback Period | Months to recover CAC | <12 months ideal |
| Gross Margin | Revenue - COGS / Revenue | >60% for software |
| Contribution Margin | After variable costs | Path to profitability |
| Burn Multiple | Net Burn / Net New ARR | <2x is efficient |
The Path Question
"Can this company be profitable at scale?"
Even if the company is burning cash now, VCs need to see a credible path to positive unit economics. Growth without economics doesn't build value.
How Evaluation Changes by Stage
Stage-Specific Focus
| Term | Definition | Note |
|---|---|---|
| Pre-Seed | Team, market, vision | Little/no product yet |
| Seed | Team, market, early product | Some initial traction |
| Series A | Product-market fit, repeatable sales | $1M+ ARR typically |
| Series B | Unit economics, scalable growth | Proven model |
| Series C+ | Market leadership, profitability path | Category winner |
Interview Questions
Key Takeaways
Key Takeaway
- 5 factors: Team, Market, Product, Traction, Unit Economics
- Early stage: Team and market matter most
- Later stage: Traction and economics matter most
- Market size sets the ceiling – Great execution can't overcome a small market
- Unit economics must work – Growth without economics destroys value