08/28/2017 12:00:00 AM
Five Core Criteria Every Investor Needs To Consider Before Signing The Check
This article was first published in Business Today Egypt and is republished with their permission.
As venture capitalists, we are often asked how we make investment decisions. There is an assumption in the market that it is based on rigid metrics. The reality is far more flexible than that. In fact, the market dictates that we be more flexible.
As investors, we are first and foremost tradespeople with a know-how that we have developed over years of looking at investment opportunities and startups and learning from their successes and failures. This know-how is hard to quantify, but for us here at A15, this translates into five fundamental questions we ask ourselves when making an investment decision.
This is not a secret sauce. Even as we answer each of the five core questions, a decision is a function of market dynamics and opportunity costs despite what the answers might suggest.
Below are how we think about opportunities that come our way and the questions we ask ourselves before we make an investment decision.
1) Does this startup solve a real problem?
The first question we ask is whether the startup being pitched to us solves a real problem. This is fundamentally a question about market size. What makes a problem real to us is whether or not enough people have it or can relate to it. If people cannot relate to the problem you are solving, your company will not reach the size that will make it an appealing investment decision for a venture capital fund.
What we expect here are concrete figures that can help us quantify the size of the opportunity. They have to directly relate to the problem you are solving not just abstract statistics about Internet penetration and the number of mobile phones. In order to grow, there must be enough people who would buy your product or service because they have this specific problem.
Make sure you have a solid idea as to the size of the market that you are targeting before you talk to an investor.
2) Does this startup solve a real problem for real people?
What does real people mean? It means product-market fit. Does your product or service deliver the right solution to solve this problem? According to Tren Griffin from A16z, you can always feel it when product-market fit is not happening. As investors, we do not want that feeling. At the very least we need to feel that it could happen or has the potential to happen.
As a seed investor, A15 does not expect companies that apply for funding to have answered the product-market fit question. While highly desirable, it is extremely rare at this stage and we know that. What we look for here is a bit more granular. Are you aware that this is something that will require a lot of audience development testing? Are you aware of the challenges and the feedback cycle you have to run in order to get there? Do you understand that you have to constantly adapt and change to maintain product-market fit as competition intensifies? We need to see too that this is something that you will constantly pursue before we decide to work with you.
3) Are you the right people to make this happen?
Experienced venture capitalists such as Mark Suster, Managing Partner at Upfront Ventures, places a 70% premium on the strength of the team. Research by Tucker J. Marion published in Harvard Business Review for example has come out to say female founders are better than male founders (Will the real female founders please stand up?). Even within a team some factors are still important and can have a serious impact on the trajectory of a company. In short, yes, the team matters, but it is not the only factor.
That said, when we are assessing a team, here are some of the things we look at. These include, but are not limited to: education, previous work experience, complementary skills, startup experience, previously failed startup experience and experience at top tech companies. A team that is willing to listen to feedback is also important. Startups are a constantly iterative process based on feedback. If we sense that you are not willing to listen to feedback, then how will you evolve as you listen to feedback from your customers?
What we also look for in the team is not just its ability, but also our own ability to work with that team and vice versa. Venture capital is about relationships, and we look for people we can work with and people who are keen on working with us. It is a two-way street. This is a lot more important than you might think.
4) Is this company really growing?
We can never do the importance of growth the justice it deserves. This statement in and of itself should be sufficient to give you an idea how important growth is to the investor’s decision-making process.
To talk about growth without mentioning Paul Graham’s classic blogpost on growth would be considered criminal. It is a must read to help any entrepreneur understand what investors look for and what they mean by growth. It also helps explain why investors are interested in startups and why we are always keen to work with entrepreneurs.
When investors talk about growth, they are usually talking about one of two things (usually both). Growth in revenues and/or in active users. We need to see growth in at least one if not both of those metrics. In pre-seed and seed-stage ventures, we would look at week-on- week growth. It gives us an idea of how many times your company would have grown in a year’s time—the higher your weekly growth rate the better.
Without growth, which for obvious reasons requires an MVP, an investor cannot really tell where your startup is headed. In a market with a very high opportunity cost like Egypt, any investor is bound to expect clear evidence of traction and a growth rate that keeps growing, so please make sure that from day one you record your traction using the many analytics tools available.
5) Is this the right time to do what you are doing?
There is one more dimension that we at A15 consider when making an investment decision: timing. This is probably the most subtle and abstract one of them all. The veteran Angel Investor, Ronald Conway, has always said “any time is a good time to start a company,” but it seems “being on time” can be the most important factor that impacts a startup’s success.
Look at the social media space, for example. While MySpace, launched in 2003, laid the foundation for changing the online behavior of users to become more socially active online, it was actually Facebook, first launched in 2004-2005, which benefited from the skyrocketing growth in global Internet penetration that happened around that time.
The founder of Idea Lab, Bill Gross, argues that 42% of a startup’s success can be attributed to timing. And while timing is indeed an external factor, it is something you should be cognizant of and take additional care to position carefully when seeking investment.
When it comes to making an investment decision, there are certainly no golden rules. However, there are key areas of inquiry that every investor focuses on. When you pitch your startup to an investor, be prepared for questions in those areas. Most importantly, be prepared with clear and direct answers to these questions, and when data is required, make sure you have it.