“We invest into People first. Everything else is secondary”
It takes more than a patent or a secret sauce to drive a startup to become a world class business.
There are countless examples of when great entrepreneurs have taken a moderately good idea and taken it to a level of outstanding success. On the contrary, there are very few companies with mediocre founders who have turned a “great idea” into a great company.
Techniques of evaluating companies for their potential as investment have been studied and practiced by some of the world’s brightest minds, from Graham and Dodd to Warren Buffett. In our field of startup investing, we believe, investment analysis remains more of an art rather than a science. This is especially true when considering an investment into a pre-revenue company with an MVP and just one customer or none at all. We find typical investment analysis models cannot or can only be partially applied in these scenarios.
Identifying tomorrow’s superstars is a particularly elusive task even for the best angel investors out there. So how do some do it so well? What are some practical guidelines to follow when considering an investment in seed stage companies?
Say for example you have narrowed down your next potential investment to two companies. One is an incredibly ground breaking business with a very convincing founder who is considered a master in his field. The other is a solid business concept in a competitive marketplace with a founder who already has a previous successful exit. Tough choice isn’t it? Some early stage investors would pick the master while others would choose the latter. Let me explain why.
Entrepreneurship is at the core of starting a company, whether tech-based or otherwise. It is not to be confused with the functional skills of coding or selling or business operations. Instead, it consists of a combination of character, skills, knowledge, experience, and willingness to take risks that brings together all of these pieces and creates an enterprise that fills a value-producing role in our economy.
In many circumstances as angels you may meet a founder perhaps once or twice in a live pitch environment. Then you follow up with a secondary meeting to learn more and then usually by the third and fourth meeting you’re writing a cheque. This limited amount time spent with someone makes it quite difficult to learn more about them so here are 10 fundamentals we use to critique our founders.
We recommend spending at least 20 hours on due diligence much of which should be spent on getting to know the founder and the team especially in a company where there is a lack of financial data. Develop some questions to ask founders and discover whether or not they possess the qualities of an ideal founder.
1. Domain Expertise – While newcomers to an industry can often bring out-of-the box perspective, we have learned through several failed investments, the importance of understanding the market in which you hope to operate. In one example a company we invested into had a founder who had extensive experience and knowledge in finance, securities and mining. The company they started was in the CPG (consumer packaged goods) space. As an investor the company was very easy to deal with. They had a great understanding of structuring the deal for us and made the process very easy. However, when it came time to execute the founder didn’t have the necessary foresight required to navigate through all of the regulatory framework set by the Government for natural health products. This made getting their product on a shelf difficult. It made everything more difficult. The entire go-to-market strategy in place needed to be delayed and much of what they wanted to advertise was not allowed. This created several roadblocks and what’s even worse is the founder was not willing to pivot on their idea and consider a different approach. Eventually we came to a standstill. The company ran out of money and then had to lead a down round to try to stay alive. Don’t find yourself in this circumstance! Spend time on due diligence and make sure your founder has domain expertise.
2. Commitment to the venture – The last thing you want is a founder who will cut and run the first time the going gets tough. Things do get dicey and you may find yourself sitting across from your founder at a coffee shop because they have been kicked out of their office or they lost their most valuable customer or a co-founder is holding the company for ransom or they face non-compliance and need more money to get it fixed or Google announced they are getting into the space they are operating in. These are all real life scenarios by the way. The wonderful world of startup investing is highly unpredictable and the last thing you want to do is invest in a founder that is running the company on a part time basis with a bridge to a backup plan if things get too difficult. We want founders that have burned all their bridges and have no choice left other than to succeed.
3. Passionate – Starting a business is much more a labour of the heart than it is the mind. Passion comes in many flavours: some loud, some internalize, some verbal, some shown by actions. It doesn’t matter if the passion is the quiet passion or the loud passion. All that matters is that it’s there! Obviously, passion alone doesn’t make a successful entrepreneur. But without it, all the talent, intelligence, and experience in the world is not likely to produce the results we look for as a VC. The entrepreneur needs to have something driving her through the sleepless nights and agonized days of getting a company off the ground.
4. Startup experience – No one wants to be a dental hygienists first patient or a stylist’s first haircut! No book, school, mentoring, or apprenticeship can substitute for hands-on experience. My sister spent two years in pre-med, four years in medical school, one year in internship, and two years in residency before she was trusted with patients in an unsupervised environment. Is creating a viable company as difficult as treating a patient? That depends. Are you willing to take a chance? Several studies have shown a positive correlation between past and future entrepreneurial success, but the same studies showed no correlation between past entrepreneurial failure and future success. Therefore, regardless if they have failed in the past it is logical for investors to lean toward experienced entrepreneurs.
5. Operating Skills – A startup requires the same major job functions as a large company and the founder often has to fill every one of them personally. The term jack of all trades master of none is a misleading phrase. You want the jack of all trades in your startup founder. It is helpful if the entrepreneurial package includes skills in product development, sales and marketing, finance, operations, business development, fundraising and so on. The more of these skills the founder has, the better the company’s chance of succeeding.
6. Leadership ability – If the entrepreneur is not an Elon Musk type ninja coder salesman-finance wizard, then they need to recruit other people to fill those roles. That is incredibly hard to do for a risky startup on a small budget. What kind of leadership qualities does this CEO possess? Can I see myself working for this person? Would I follow them through fire in pursuit of our common objective? Have they ever built and led a team before? Do they play team sports? What position did they play? Are they a centre of influence? Can they attract and manage talent? We look for these qualities both on paper and in person.
7. Long-term vision – Entrepreneurs who start their own company must be able to convince investors of their vision to create something significant and meaningful. Just as a great athlete is able to swing through the point of impact in golf or baseball toward a target hundreds of yards away, founders should be able to aim for the stars while carrying out the day-to-day operations of their business! We are looking for a perfect balance of vision and execution.
8. Realism and pragmatism – We look for optimism as a trait but it has to be optimism based on realistic understanding of how things work. The biggest turn off in a pitch deck is the over exaggerations and rosy promises of penetrating 10% of the TAM (total addressable market). Instead we want to know about who their first customer is, and then their second, their third, how will they attract them, what channels will they use? How much will it cost to attract these customers, etc. We prefer to work with a gritty business person who is in total command of their startups numbers, customers, channels, sales projections, production costs, and more.
9. Integrity – This one requires some EQ on the investor’s part. Have you ever said to yourself “I should have trusted my gut feeling?”. We are all born with intuition and if something inside you is off about a person then it’s best to walk away EVEN if it’s a great company. A lesson I’ve learned after is that if the relationship doesn’t start off on the right foot it will almost always remain on the wrong foot. Plus, we are in the business of working with the people we want to work with.
10. Flexibility – The most successful companies today have at one point or another pivoted their business model. This is true for companies such as Tote which later became Pinterest or more famously Odeo that is now Twitter. In all of our investments unplanned things occurred. There’s a great quote that says “Everyone has a game plan until they are punched in face” and that’s exactly the case in the startup world. A punch in the face will require the founder to adapt to their environment and devise a counter strategy to overcome their challenges. The entrepreneur needs to be able to adapt and pivot if necessary to deal with problems and to take advantage of other opportunities!
What are some qualities you look for when you invest in a founder?