How do we assess an investment opportunity?

I can’t remember the number of times I was asked that question. “What do you look for in a startup?” “What would make you invest?”. I thought I’d share my approach. I know other early stage investors take a similar approach but I will only speak for myself.

Two theories guide me in an early-stage investment:

  1. The notion that most business plans will change once assumptions “meet the market”. Given that I rarely read business plans or care to see one. I’ve shared my thoughts about business plans here.
  2. The notion that an early stage startup is a hypothesis with many assumptions. Therefore, the risk is the ratio between the assumptions that were validated and the ones that were not validated yet.

Given that, the 6 most important elements I look at when assessing an investment in an early stage startup are:

The team – Is the team competent, are they focused on vision or execution, how analytical are they when it comes to product/customers, how well do they know their customers and competitors and how receptive are they to feedback. The process they went through so far is, what I found to be, a good indication of the future and so I spend a fair amount of time listening to their story and how the idea evolved. I also tend to assess what milestones they met so far (partnerships, number of customers etc.).

Barriers/defensibility – How easy would it be for someone to replicate the idea. Have they created a barrier to entry or do they have a proprietary technology/data that is valuable enough, even if their initial business model fails. A good example would be a company I saw a while ago named Centzy. The founders found a way to get accurate pricing data for local businesses that was dramatically cheaper than current methods. Such data is most valuable to companies like Yelp, Google and others and so I was confident they’ll find a way to monetize that value.

Scale – Some would call that the viral coefficient. Can the method used to acquire the first customer be used to scale and acquire many customers. Is it scalable. Can it be replicated.

The product – I never know what might fail and I don’t think anyone can. I never consider myself the typical customer, for good and bad. I only assess the product to the extent of whether it’s a vitamin or a pain killer. Does it solve a real problem or it is just a nice to have product. I tend to shy away from products which I consider features vs. standalone products.

Analytics – I tend to ask the founders for the 2-3 metrics they watch to assess how they are doing. Cost of acquisition, MAU, life time value would be a good start if you are an online consumer startup. I’m a big believer in numbers since numbers are hard to argue with.

Market – I know that many VCs are looking for startups in big and growing markets, assuming the startup will take a portion of that growth. That, in my view, led to so many group buying/Social networks/photo sharing/content discovery startups. I just want to know the company doesn’t target a 90% market share to reach $20M in revenues.

Some final suggestions:

-          Be respectful in your communication style: send follow-up emails and reply in a timely manner.

-          Have a compelling Executive summary that is interesting yet simple. Think about it as a brochure and use it to make your startup shine.

-          Know your investor. Read about his background, previous investments, blog posts and tweets etc. Be prepared.

-          Know your competition. “We have no competition” eliminates your chances to get funding. Not knowing about one is likely to have a similar effect.

-          Don’t send a LinkedIn invite before we meet. I don’t know you and therefore I’m not likely to respond (you can’t imagine how many entrepreneurs do that).

- Reference from a trusted source is always advised. (Thanks for that Thorsten !)

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About shanishoham

After 14 years of General Management and incubating/scaling new businesses & organizations for enterprises (established a $55M mobile business and a $100M/400 employees global division), I became an investor Today I’m a board member/mentor with 5 incubators & micro-VCs and involved with many other private & public incubators around the world. I also founded a VC firm named 2020 and I'm a member with a number of angel groups so i get to see & work with many startups, innovation centers and other parties across the ecosystem. I’m an alumnus of the Stanford Graduate School of business - Sloan Master in Management program, a 10 months intensive program for 57 carefully selected experienced Executives and leaders from all around the world.

15 comments

  1. ihab kanaan

    Dear Sir. I am very impresed with what I read. I would like to have contact with you, if you don´t mind. I have several ideas and I hope to learn from you experience.

    Best regards.

    I Kanaan

  2. Sergei P.

    You are thinking in a manner of how the standalone product can conquer the market. But this approach can be simplified: how the project can gain the customers, and how fast it can form the loyal customer base and how long it can retain it? Or simplier: what products, platforms, features can attract and retain the customers?

    Today, for example, we have the phase of CONNECTIVITY in Internet when customers are very interested in various products. But when the USABILITY phase begins, customers will be consolidated around integrated platforms and investing philosophy will change. And product will not be regarded as vitamin or a pain killer, but as a new business opportunities. But not yet…

  3. Lee Morrison

    Shani,
    Thank you for the very informative article. My partner and I bring a combined 50 years of industry experiance to our model. We have been in the Value Reseller Market for Technology and have existing clients as well as plans to bring onboard 12 senior sales professionals with existing business as well. Our model is a variation of a total solution provider program incorporating hardware, software, services (both traditional and cloud), in addition to vertical markets that are rarely tapped into this framework. Based on past performace, we are anticipating monthly sales in the range of $2m. Our client base covers, Federal, State, Local Government, Education and Corporate. We are also a Veteran owned company. Is there a dollar starting point you view as worthy of your interest from a seed capital position? We have a 6 month requirement that is less than $500k. I would greatly appreciate your feedback. Thank you for your time and consideration.

  4. Dom

    Good morning and thank you for taking the time to post and share your thinking / criteria.

    I am sure, like all active investors you are bombarded with a high volume of disparate pitches and spend an equally disproportionate amount of your time reviewing them (and having to sensitively say no…)

    The Angel / VC pain point…!

    We have built the architecture to distill, capture and share the communication of ‘any’ start up pitch down to the key components you outline above (plus one or two others…) so that a first pass, entertaining and visual review can meaningfully be made in thirty seconds (market, pain-point, scale) and a second qualification pass within five minutes (team, business model, traction, metrics)

    Would absolutely love to get feedback and a sense check on our thinking / progress if you ever have a moment!

    Many thanks

    Dom

  5. funny – you write an article about the six important elements and all you get is unsolicited “dealflow” :) Maybe you should’ve added “referenced dealflow or introduction from a trusted source” for pre-qualification….

  6. Dom

    Apologies Shani / Thorsten, did not intend to be pitching. Simply trying to highlight that the requisite elements sought are absolutely those that we should all be working through and articulating crisply when fundraising.

    The amount of plans that I see that miss these fundamentals always surprises me.

    And this only equal to the number of active investors who are inundated with weighty documents missing the key points! Please feel free to edit / delete my post as you feel appropriate and again, apologies.

  7. @Thorsten, that’s a great addition ! Totally forgot about that (see update).

    @Dom, @Lee and others, see my contact information on the about page. Send me a short Executive summary and i will try to read through the information.

  8. Good one. I esp. like:
    “Therefore, the risk is the ratio between the assumptions that were validated and the ones that were not validated yet.”

    That’s so true, & focusing on that will make entrepreneurs really do the hard early work, in validating as many key assumptions as possible. That helps their success, & not just an investor’s success.

  9. Great article Shani. One question about this line:

    “are they focused on vision or execution”

    You didn’t say which they should be focused on, I have a feeling you were leaning toward execution…but what about both?

    In my own team, we spend a lot of time establishing a vision…and then drive execution towards it. If the execution isn’t producing trends that point toward results, we back up, re-focus on the vision for a while, then drive with execution again. This strategy is working 10x better for us; and we’ve found without a vision kept at the forefront of a team’s mind…motivation is lost, the team runs off in different directions, & execution becomes nothing more than wasted efforts. Likewise, if you spend too much time in the vision phase without execution nothing gets produced; nothing gets validated. So it’s both, right?

    • Amanda,

      Short answer: you are right. Both are important.

      Long answer is divided by two parts:
      Part 1 – I think you might be confusing vision with strategy: A vision is kind of the north star. It defines who you are and where you are heading. It’s a goal you will never really achieve or be able to measure (e.g Google’s vision: “Organize the world’s information and make it universally accessible and useful.”). What you are probably pivoting around is your strategy. The short term path that you choose towards reaching your next milestone. The distribution channel you use, acquisition methods, business model & pricing, target customers, partners etc. Again, you know where you are going, you define your milestones and change paths on the way towards your next milestone.

      Part 2 – I strongly believe that at some point the benefit of planning and research is marginal vs. the value of executing and pivoting. Launching a MVP and slowly trying different channels to reach a selected group of customers and analyzing the results will probably make a huge leap in the learning curve.

      So again, strategy and execution should be combined together (execution, analysis and strategy pivoting).

      i would favor a team that launched something quick and pivot vs. a team that spent 9 months to define their strategy but did zero to prove portions of their strategy.

      Finally, it is also important to execute on the right stuff.

  10. I see…so it is really the strategy then, and not the vision, that keeps changing. And you’re saying this “normal” or good, right? Always felt this was the best way to build a company…but received mixed signals about it. And…what are the right things to execute on?

    For example, when I try to explain the importance of the market pace, putting something out, analysis, adjusting strategy as you go (which changes the business plan)….the local angels we’ve pitched to don’t like it. They want all the details of how to get there carefully planned out in 50 pages, then spend 6 months picking through it. By the time they finish, the details have changed again, and I can’t close the deal. In cases like these, do you bear through it…or just move on?

    Thank you again, it’s all very great information.

    • I would hesitate to tell you what to focus on without knowing the details but as i mentioned in the post an early stage startup is making a bunch of assumptions. Focus on the actions that help you test those assumptions in the most minimal way possible.

      As for a 50 pages business plan, I usually don’t read those for the reasons mentioned in the post. I talk to the team to figure out the assumptions, risks, their track record so far etc.

  11. Pingback: How do we assess an investment opportunity? – Part II (and the importance of focus) « Shani's Business Review (SBR)

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