Get Your Money's Worth: What Investors Should Look For In A Startup
The key determinant of funding for angel investors (or any investor in general) is to understand if the company they are interested in is fundable or not. The key thing to remember here is that it is relatively easy to raise money for a company that is fundable. It is close to impossible to raise funding for a company that is not considered fundable.
This is something important that investors need to keep in mind before moving forth on an investment, because startups typically need to go through several funding rounds before they hit it big or even become cash flow positive. So it is critical that investors evaluate and understand if a startup is fundable in the eyes of other potential follow-on investors. Failing this, the investor faces the risk of ending up as the only investor in the next financing rounds.
So, what should investors look for in a startup? There are essentially three focus areas: the market, the product, and the team.
Good investors love markets that structurally do not present a hindrance to hyper growth. Typically, the overall global market of the startup you want to invest in should be north of US$10 billion, and have an addressable market of more than $1 billion on entry. This means that owning 10% slice of the addressable market makes a $100 million revenue company. If the market is either a niche or totally new, you can start by evaluating the total addressable market at a few hundreds of millions (or zero), but the expectation has to be that the startup will quickly grow because of the competitive advantage, becoming an undisputed market leader. When evaluating this particular focus area, here are a few red flags you should be aware of:
Size Some markets are simply too small to justify a VC level investment. They might still be good opportunities for a lifestyle company, or an angel-funded feature that is either sold or reaches breakeven at relatively small amount of money of less than a million dollars.
Competition Some markets are extremely overcrowded.
Readiness Some markets are not ready right now.
Risk Some markets require a Minimum Viable Product that is too large and too risky for a startup.
Flexibility Some market spaces offer tremendous potential for pivoting whereas others are too rigid. They only offer feasibility if the initial product or go-to-market angle succeeds.
A quality product at the right time and place can make or break a company’s fortune. Simplicity is key. The basic rule of thumb is that customers will initially only buy a simple product with a singular value proposition. The product shows to the team itself and the investor that this specific team can actually build something together, beyond mere PowerPoint slides. It reduces perceived and actual risk for the investor. When developing new innovations, startups normally go through an evolutionary path from feature, to product, to company.
As an investor you should not be afraid to look at startups which only have a “feature,” as opposed to a full-fledged product, as long as they have a realistic evolving roadmap on how to move onwards from the initial feature towards the real product and the company.
As for red flags, be wary of a lack of laser focus in the product, business model or go-to-market strategy.
Product and market are far more important determinants of a startup’s meteoric success than a team; however, both these features are way more difficult to measure in the early days, thus making the team an important qualifier. Without a good and dedicated team, everything will go south quite quickly. Each opportunity is distinct and calls for a different composition and backgrounds for the ideal team. But desirable characteristics would be:
Drive The founders must have sufficient energy and conviction to carry them through the ups and downs they will inevitably face.
Communication Founders must also be able to communicate their drive and enthusiasm to their employees in such a way that it becomes contagious and part of the company’s culture.
Agility They must be able to swiftly execute against the market opportunity.
Dynamicity The ideal team composition changes over time as the company evolves and fine tunes its direction, as well as increases the maturity in the given direction.
Nimbleness The market is competitive; the team must be able to go-to-market on a timely manner against the competition.
There are red flags to consider here as well:
Team structure Team composition is lacking, for instance, a product lead is missing or is not good enough.
Division of equity The equity pie has not been divided fairly or is otherwise weird.
Corporate culture Issues with team culture, for instance, one independent cowboy instead of a cohesive group.
At the end of the day, while going through a startup’s investor deck, make it a point to evaluate if the startup can present their fundable company in a form of story with interesting narrative. A great plan is one that can be distilled to a very simple proposition, without losing its attractiveness. If a company’s plan is not simple enough to be described in two sentences, it probably is too complex to be communicated effectively to customers, employees and shareholders. Substance is far more important than images and the color of the lines.
Angel Rising is an annual symposium organized by startAD and VentureSouq that provides education sessions on key topics related to Angel Investing to individuals from the region who have expressed an interest in investing in startups. This year's edition of the event is open to the public and will be held on May 13, 2017, 1:30-6:30 p.m., at the NYU Abu Dhabi Campus, Saadiyat Island.