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:
- 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.
- 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 !)