How Early-Stage Investors Decide Whether to Invest in a Startup Having a validated product or service and demonstrating market traction are essential for attracting early-stage investors. Startups are more likely to attract investment interest if they can demonstrate early consumer adoption, revenue growth, or partnerships with significant players in the industry.
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Every great business has a tenacious, dedicated founder with unwavering passion at the helm. These exceptional individuals are actively sought after by early-stage investors, especially those who have demonstrated their mettle in challenging circumstances since they have the traits needed to thrive and succeed in the face of adversity. Investors aim to make effective investments that foster innovation and contribute to the growth of the entrepreneurial ecosystem by recognising talented founders, embracing a varied range of sectors, and valuing capital efficiency. They are dedicated to creating an atmosphere where entrepreneurs can thrive, achieve their goals, and have a long-lasting influence on society.
In a tweet, the Investment Partner at Blume Ventures, Sajith Pai stated that "We get 3-3,500 startup pitches a year. We can best fund 10-12 per year. This means that we reject a lot of great startups. Some startups are rejected because they fall outside of our investment parameters or are too early or late for us to consider. Some are declined because we already hold investments in their rivals or in risk categories that are similar to them and do not wish to add to them.
"Sometimes we reject very good companies, which pass all of these criteria, because there is another company ahead of it in the mental stackrank, one that we believe is even better poised to be a bigger hyperscaled startup. So if it isn't the #1 in the stackrank at that point, the startup will be rejected. So being at the top in the VC's stackrank matters for a startup."
For this article, we talked to a few early-stage investors who discussed their decision-making process for investing in startups.
The first-mover advantage and a sizable TAM
Tomorrow Capital prioritises a few factors when evaluating possible investments over and above the tenacity of the founder and their outlook for the long-term success of the company. These include a sizable total addressable market (TAM) and a first-mover advantage in their respective space.
"We also seek for startups that have a competitive edge or a clear route to achieving one, with a preference for those that are consumer-focused or enable consumption. Another important factor is the founders' tendency towards execution and the ability to build frugally in the early stages. Since Tomorrow Capital's start, we have prioritised profitability, or a clear route to profitability, and it has always influenced our investment choices," said the CEO Rohini Prakash.
A clear product-market fit with less rivalry
According to Nandini Mansinghka, CEO of Mumbai Angels, "Before making an informed investment selection, we advise taking into account a variety of variables, including an assessment of the founding team, traction, pre-valuation revenue, valuation division, market size, competition, etc. Startups that operate in markets with less competition and have a clear product-market fit are also in good shape."
Focus on founders' background and early levels of traction
DevX Venture Fund invests in founders who either had a previous exit or the founder understands the domain in and out. "Moreover, we invest at early traction levels when PMF (product market fit) is established or about to be established, which gives us comfort in the future outlook of the venture. It helps us filter out startups in a seamless manner as we invest usually at a fundraise of $1 million at a median valuation of $3 million-$5 million," added Co-founder Umesh Uttamchandani.
A favourable return and the ability to see big
Shashank Randev, Founder VC, 100X.VC said that the investment choice is made based on the founders' experience and expertise, market potential, moats or intellectual property, and the fund's capacity to create wealth in order to generate at least a 20x return. Shun can be if founders are moonlighting, not having a vision to scale and not having a mindset of capital preservation.
Capital efficiency ability
IvyCap Ventures firmly believed in supporting startups that demonstrate the ability to efficiently allocate and utilize capital, leading to maximum value creation. "We understand the importance of responsible and strategic financial management, and we actively seek out entrepreneurs who share this vision," highlighted Founder and Managing Partner Vikram Gupta.
A strong team and the ability to solve problems
The most important things to evaluate, as per Seema Chaturvedi, Founding Partner of AWE Funds, are if the firm is addressing a pressing issue or offering a much-needed solution. Second, does the team possess the necessary skills to carry out its plan and bring about the desired results? "We prefer an A team with a B business plan versus a B team with an A business plan. The team composition is super critical. Lastly, is the opportunity scalable in a manner that our investment value can appreciate or not."
Building a lucrative and sustainable business
A red flag for investors, emphasised Jatin Karani, Co-founder and Partner, Samarthya Investment Advisors, is when founders seem to be chasing valuation rather than focusing on value creation. Building a sustainable and profitable business should be the priority, not inflated valuations. Startups operating in sectors with excessive competition and numerous well-funded competitors may find it challenging to carve out a significant market share, making them less attractive for investment.
"We are cautious of startups with unreasonable valuation expectations, particularly when these do not align with the startup's traction and operating metrics. Conversely, an overvalued startup can indicate a disconnect with market realities and present significant risks for investors," Karani said.
Evaluation based on 5 Ts
FAAD Network evaluates startups based on the 5 Ts: Team, Traction, Technology, Ten x Returns, and Terms of Investment.
"A startup's success hinges on the strength of its team, encompassing the essential skills, passion, and resilience required to navigate challenges. Traction serves as a testament to market validation and customer adoption, while groundbreaking technology fuels innovation and disruption. The potential for ten x returns acts as a significant motivator, alongside favorable terms of investment, which play a crucial role in our decision-making process," shared the Co-founder and Director Karan Verma.