#18 | Why Early Stage Investors Pass On Deals
The Agile Growth Entrepreneur Newsletter
Welcome to this week's Agile Growth Entrepreneur Newsletter.
Most venture capital firms, including ours, look at several startup deals weekly. To weed out opportunities that don't meet our standard investing requirements, we've created a screening process (e.g., industry, stage, model).
Transactions beyond this first vetting stage are then investigated with additional care. A complete analysis of the company, its product, and industry is conducted, including a study of the deck, financial statements, and predictions; interviews with the company's founders, customers, and investors; and a survey of pertinent third-party information. The process involves many rounds of elimination for companies, and only a fraction of the bids we assess will result in an investment.
In the hopes that some founders would find this post useful in increasing their prospects of obtaining financing, we will explore the 11 most prevalent reasons why we decide not to invest in startups.
The absence of honesty or transparency. If we find that a startup's founder is being dishonest, we will quickly lose interest. Relationships are the foundation of the venture capital industry; therefore, being secretive is not a good first step in building trust.
Nothing proprietary/innovative. A company's success might spell its doom if it doesn't have a unique selling proposition (USP) that can be defended against competitors.
So, let me explain what I mean. The company's success may be duplicated by competitors since no moat is protecting it. The more popular it becomes, the more rivals will want to copy it. However, suppose it has a secret sauce, such as innovative methods, proprietary data, insider information, or influential contacts. In that case, the company can achieve and maintain rapid expansion better. While having the first mover advantage might be beneficial in the beginning stages, it often doesn't amount to much in the end (e.g., Myspace).
No tested and effective monetization methods. As investors, we look for companies where our money may help drive the expansion of existing lines of business. A company is more likely to waste its money on trial and error if it has not yet found scalable, cost-effective marketing channels.
We'd rather put our money into businesses that have already done some of this groundwork so they can focus on expanding the successful channels. When asked about expansion, we appreciate hearing from entrepreneurs who have a solid grasp of paid customer acquisition rather than the standard response, "We're hiring a growth hacker."
Don't know your Key Performance Indicators (KPIs). We discover that the success of a startup is proportional to the founder's familiarity with key performance indicators.
As a first step, startup founders must show they have a firm grasp on the KPIs that matter most for their venture. They must also show that they are accurately measuring and calculating these metrics. Last but not least, they need to be aware of the knobs and dials that may be turned to alter each KPI and the metrics that need to be adjusted to ensure the company's success.
TAM is too small. Businesses often come up with unique and even innovative answers to problems experienced by a niche audience. One of the most important factors in determining a company's ability to achieve exit velocity is whether or not the market being addressed is large enough to make the company's potential for future growth in revenue noteworthy to a prospective acquirer. We typically don't invest in a startup until it can convince us that the market for its solutions is substantial.
Pre-revenue or pre-ship. We found that when a company makes its first sale, the investment risk drops significantly, especially compared to the rise in value. In other words, once a company moves through the pre-revenue phase and begins building and selling a product for which customers are prepared to pay, the risk involved lowers while the value grows. In light of this, we believe investing is best after a startup has achieved this first sale and shown early signs of product-market fit.
No Vision: When considering an investment, we look for startups with founders who can articulate a plan to multiply the business by a factor of 100. Of course, there will be deviations from this goal along the way, but without it, the company would have a very hard time succeeding. Amid the wildest storms, founders can always find their way back to the North Star.
Lopsided founding team. There is an absolute need for both production and sales. These responsibilities call for distinct sets of expertise, which are not often found in the same persons. If the founding team has expertise in many areas, including engineering, development, sales, and marketing, that's even better.
A company's ability to produce high-quality and marketable goods depends on integrating several disciplines from the outset. To improve in areas where they fall short, businesses may go out and employ experts, but doing so removes those skills from the core of the organization. Furthermore, it is always preferable if the people handling the contracted labor have prior expertise in the field.
No skin in the game. We want to ensure that founders are 100 percent devoted to the firm before we invest. They must work for the company at least full time as a basic minimum need. Ideally, they have also put a considerable amount of their own money into the firm.
This is by no means an all-inclusive list. Still, it should serve as a useful checklist for founders to ensure they address some of the most frequent reasons why we (and likely other early-stage investors) pass on deals. And by the way, we'd love to hear from you if you're already doing everything right.
