The entrepreneurs spend a lot of time thinking about their business, their product, their team and how they are going to build a success. The challenge for most startups is startups don’t spend enough time talking about money. Specifically, how much money do they have and how much money do they need to build the product and actually get enough traction with customers at the marketplace so when they go out to raise capital, they can actually be successful in raising that capital.
The criteria for an investor is often very different than the criteria that entrepreneurs evaluate what they are doing. The entrepreneurs look at their product, they look at the technology and the investors are spending their time asking the question is this a good business and can I make money.
When a startup company is investible?
There are several different ways that you can look at that and evaluate the company. First, and perhaps the most important is a business – it’s not an idea, it’s not just a product. Has the company come together with a business plan? Has the company really demonstrated that they know what business they’re in, in terms of identifying the product market? Has there been enough market research and market validation to determine that the market really exist? Has the company showed the evidence that they’re focused on the market? Has the company put the team together?
What kind of investment are suitable for angel investment?
Firstly, there are companies that are not capital intensive. If a company requires tens of millions of dollars of private money to build a success early on, those are not business well suited for angel investment and many of those are not businesses well suited even for VC investment.
Suitable angel investments are companies where a small amount of money can help in making meaningful progress on the product as well as on the market. Suitable angel investments are companies where large amounts of money are not required until after market validation is proven. The only exception is the companies in the medical field, where the market is clear – often that market validation is not required early on.
The best kinds of angel investments are in companies where angels bring value beyond simple their money – where they bring adult supervision, the leadership, the expertise, potential customers, and most importantly – their book of contacts and relationships that can help the company build its team, and help with introduction to a potential customers.
Ask key questions
The key questions that you need to ask :
- Is there a business, is it a viable business?
- Has the company the clarity around the problem that they are solving, the solution and who the target customer is?
- Has the company identified why this is an opportunity, why this can be a big business now and how this team can successfully execute on the plan?
- Can this become a big business? If it’s going to be a small business that’s probably a perfectly good business for the entrepreneur to be founding, but it may not be a good business for angel investment or for later rounds of VC investment.
- How does what this startup is doing stack up versus other competitors in the marketplace? And in any marketplace, one would expect to see competitors, competitors who are in the market in the country today or potentially companies who might enter the market in the future.
The value of lawyers
Lawyers are important when companies are established and when there is a financing it’s really critical that lawyers get involved in the process. When a company is doing a financing, everybody needs a lawyer – the company needs a lawyer, the investor needs a lawyer. Good lawyers provide legal advice and counsel but they can provide so much more. Good lawyers are an essential part of a startup’s team – they provide perspective, they provide knowledge and help the company to avoid disasters by doing things the wrong way or failing to do the thing that needs to be done.
How much money?
The goal is to raise money based on milestones and things that the company will accomplish over the 12-18 month period of time. How much time you give the company between financings is a question of how long a leash investors want to give to a management team. If you don’t give the management team enough time they really are constrained on what they can execute, who they can hire and how much planning they can do. On the other hand, if you give companies money that will last three or four years than the management team really doesn’t have the incentive to necessarily accomplish the things in a short period of time. Too much money doesn’t challenge companies, doesn’t challenge them to be lean and resourceful.
Is the plan realistic? Can a team execute on the plan?
- Does the team understand the feedback from the marketplace, from the investors?
- Does the team know how to change the direction when and if appropriate? As things change, it’s really important to know that the team that you’re investing in won’t get paralyzed, but thoughtfully make changes on sound judgment.
Teams are not about people being friends, it’s about people who bring complementary background and experience, and know how to work together and make good decisions as a group. In early teams sometimes you find that people don’t have titles, and it’s really important to know what peoples’ job is, understand who the CEO is and who makes the final decision in the company.
- Does the team have the right diverse experience to achieve the milestones?
- Does the team know how to react when things crash and burn?
Investors don’t run companies and they should not – they invest in the company. After they invest, investors have an important role to be supportive of the company, of the company management but also to ask the tough questions and make sure the company is being accountable. Some investors get access to information about the company’s financing and management.
My rules of thumb
Early stage investors lose money on most deals. This is a business where 70-80% of your investments will not be successful. As a result of that, making a single venture investment is likely to fail. And the most successful angel investors and venture capital investors take a portfolio approach, where over a time they are investors in not one or two companies but they are investors in 5-20 companies.
The simple reality is that there is no such a thing as a sure bet. So when a fellow investor says to you This company can’t fail, be wary.