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Win an Investor's Money by Acing These 5 Questions Entrepreneurs are put to the test before a financier writes a check. The ones that provide excellent answers score.

By Peter S. Cohan Edited by Dan Bova

Opinions expressed by Entrepreneur contributors are their own.

Investing in startups is a risky game with enormous potential payoffs for the lucky winners. Through sweat equity, entrepreneurs are investors in their ventures but as strategists and operators, they must also persuade capital providers to write checks.

My experience investing in startups and the research for my 2012 book, Hungry Start-up Strategy, suggest that capital providers should grade startups before deciding to invest.

How can an entrepreneur ace the test for raising capital? Answer the following five questions brilliantly.

Related: 5 Questions the Right Investor Will Ask You

1. Is your company targeting a huge market?

Investors are inclined to finance startups that are aiming to generate revenue from huge markets. That's because in the most optimistic scenario, the venture gains 10 percent of that market.

And since a rule of thumb is that most startups need at least $100 million in revenue to go public, an investor will be happier if the startup is targeting a market of at least $1 billion in revenue.

Consider the example of LendingClub, a peer-to-peer lender to consumers that went public on Dec.11.

According to its prospectus, LendingClub is pursuing a huge market that would certainly satisfy investors: The total consumer credit market in the U.S. is $3.3 trillion and refinancing the $882 billion revolving consumer-credit segment is one of LendingClub's targets.

Most investors are interested in knowing the size of a startup's addressable market -- that is, the specific segments from which the company can draw revenue. Based on LendingClub's reported $6.2 billion in loans arranged in the past seven years, it has demonstrated an ability to tap that growing market in a compelling way.

2. Is your management team the industry's best?

Investors are on the lookout for great management teams to deal with the uncertainty involved in turning the decision to target a big market into substantial revenue.

Ideally, a CEO should be someone who knows an industry well from previous experience, is highly intelligent and motivated and capable of building a team of strong executives.

Pure Storage, a maker of flash-storage systems for companies, excels at building a great team. "We receive 200 resumes for every person we hire," its CEO, Scott Dietzen, explained to me in an interview in November. "We want people who are missionaries not mercenaries. They are people who want to change the world."

3. Can your company relieve the pain of stakeholders?

A startup should deliver a solution to problems not being solved by other companies. An entrepreneur should know all about the company's stakeholders (customers, employees, suppliers, and investors), what ails them and how the venture can relieve that pain.

Consider Evernote, a company that lets consumers keep track of all the interesting things they find online every day. As I learned from interviewing its founder, Phil Libin, for my book, he had been seeking a way to protect himself from his weak ability to organize things and had not found a service that met his need. So he started a company to solve the problem.

Now Evernote has 90 million users, which suggests that Libin's pain was shared by lots of others who are happy he developed an easy-to-use remedy for his problem.

Related: 10 Mistakes to Avoid When Pitching Investors (Infographic)

4. Do you have a special sauce?

An investor seeks to understand how a venture can gain an advantage over rivals that might try to replicate its successful strategy.

That special sauce could come from delivering a lower price for a high-quality product that makes customers happy enough to recommend the venture to people they know.

Investors look for evidence that a startup has created large numbers of customers who will recommend its services. And if the startup's marketing expenses as a percentage of revenue fall as the company grows, satisfied customers might be helping out with the venture's fortunes -- a resource that's hard to copy.

Consider two Massachusetts-based startups that make data-storage technology whose CEOs I interviewed for my book. Both of them relieve the pain of high storage costs in a way that jumps out at customers. Westboro, Mass.-based SimpliVity's product reduces by a factor of three a company's costs to acquire computer equipment and pay for the labor, space and power required to operate it. And Waltham, Mass.-based Actifio saves customers $15 for every $1 a customer invests in its product.

Both companies are creating value in a way that's hard for competitors to replicate.

5. Can the company reach $100 million in revenue?

Since a venture is unlikely to sell its shares to the public unless it's growing rapidly and has at least $100 million in revenue, investors can assess this by examining its financial results and projections. If a venture can present compelling evidence that this target is in reach, capital providers will be eager to consider writing a check.

One of the most successful startups I researched for my book is Boston-based app marketer Fiksu (the word means smart in Finnish). Since the company started selling in 2010, revenue grew 216 percent, from less than $1 million to $100 million, in three and a half years, with only $17.6 million in venture capital, as I learned from an August conversation with CEO Micah Adler.

Fiksu is surely poised for an initial public offering.

Related: 7 Taboos of Business Pitching

Peter S. Cohan

President of Peter S. Cohan & Associates

Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He is the author of Hungry Start-up Strategy (Berrett-Koehler, 2012) and a full-time visiting lecturer in strategy at Babson College in Wellesley, Mass.

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