There are far more companies looking for angel or venture capital investment than there are investors. Therefore, successful investors are going to get a large amount of potential deals coming their way.
Every angel investor must have their own method for quickly assessing the overwhelming number of pitches they receive. While every screening and due diligence approach will be different, there are many fundamentals that venture capitalist and angel investors use to assess potential opportunities.
In my previous article, The Ultimate Guide to Angel Investing, I outlined what angel investing is, how angel investors work, and how to get started. And in Top tips for new angel investors, I went into more detail, providing tips on how to make the most of your investments.
In this article, I will outline my personal approach to assessing and screening angel investments and explain why each part of my assessment criteria is important.
My investment screening criteria can be broken down into:
01. Vision
1.1 Does the vision align with my investment philosophy?
The first question you need to ask yourself is: “does this startup business fit in my specific investment areas?” There are many great businesses that I see that do not align with my investment philosophy. Therefore, even though I think they might be successful, I tend to pass on these opportunities.
Unless I am being pitched by a business with a strong technology angle that will have a significant positive impact on the world, I politely decline to go any further. This is the niche I have personally decided to focus on.
1.2 Will I be able to add massive value to this startup business?
If the business fits into your investment areas, then the next question is whether you can add value to the business. What can you bring to the table that will tip the balance of success in the startup’s favour?
Think creatively about how you could use your expertise, contacts, experience, and brainpower to help the founding team get traction and succeed. If you don’t believe in your heart that you can add massive value, then you should do the right thing and let someone else invest who could.
1.3. How compelling is the narrative around the vision?
Finding the next big Unicorn is not easy. It takes a lot of luck and skill to find an early-stage startup that will be successful. On the flip side, it is much easier to predict which businesses will fail. So you should not waste your time with these.
The startup should be able to paint a compelling picture of what it is trying to achieve. If it can’t, then move on.
You need to ask yourself “Why is this company going to be a billion-dollar unicorn?”
This is half the battle is focusing on the winners with the big markets and a clear narrative around the vision.
1.4 Why will this idea succeed now?
Chances are that there will have been many attempts to build a business in the area the startup is attempting to target.
“Google was the twelfth search engine. Facebook was the tenth social network. iPad was the twentieth tablet. It’s not who gets there first. It’s who gets there first when the market’s ready.”
Jason Calcanis
There were many video companies before YouTube, but they all charged for bandwidth and storage. This meant that if your video went viral you had to foot a huge server bill. YouTube benefited from plummeting bandwidth and storage costs, which made it much cheaper to host high traffic videos.
1.5 Will this business be insanely scalable?
One of the reasons I focus on technology businesses (other than the fact that I am a technologist) is that there is a much higher potential to become scalable in a tech business. These businesses have much larger upside potential than those that are not scalable.
Remember you are looking for a business to scale which leads to a valuation of hundreds of millions or billions of dollars. That means they need to be able to grow and acquire customers quickly.
Think about Airbnb versus a Marriott hotel chain. Airbnb can add thousands of properties at almost no extra marginal cost. The limits of their scaling is a product of how much they can sell. A Marriott hotel chain however can only scale to the limits of their existing properties. If they want to grow beyond that they need to locate, buy and refurbish a new property. This takes a lot of time. While Marriot has the potential to be as big as Airbnb, it will take them significantly longer to achieve the same scale.
02. Founding Team
2.1 Do you believe in the founding team?
Having a great startup founder and founding team can make the biggest difference between success and failure for early-stage companies. This is because there is little difference between a founder and their idea, they are one and the same.
It is much easier to pick a good founder than it is a good business idea. To be a good investor you have to be a good judge of people with great potential. While it is not scientific, you need to believe in the founding team that they will be successful in their startup.
Ask yourself the question: “Would I buy stock in this founder if I could?”
Jason Calcanis
2.2 How committed is the founder?
Look for founders that have a real passion and drive for their business. Leaders with these traits are prepared to make tough decisions, and keep moving forward in trying times. You should try and understand why the founder has chosen this business? A founder that has a strong sense of their mission is far more likely to be successful.
Founders who believe in their business vision are more likely to build a great company than those who are in it for the money.
2.3 What experience or track record do the founding team have?
Founders that have strong experience in their business area tend to achieve the best results. Before investing, look at their previous ventures and how successful they have been in the past.
Serial entrepreneurs often take a more disciplined approach toward future startup ventures. Whether they succeeded or failed in the past is not as important as how they handled that outcome. In the end, you want to work with someone that will make responsible decisions with your investment.
3. Journey to Date
3.1 What Has Their Business Journey Been Like So Far?
What has the company achieved so far? While there are no hard and fast rules, understanding this will help build a picture of how fast and coherently the team is operating. For example, if they are two years into their journey and do not have a Minimum Viable Product (MVP) then that will ring some alarm bells.
You want to see a pattern of speed, decisiveness, and agility in the journey to date.
3.2 Is there already a viable product / MVP?
Investing at the idea stage is risky – as there is more uncertainty. With an idea it is much harder to determine if your potential customers will actually pay for your product.
I prefer to invest in companies that already have a viable product they can test with real customers. In doing so, it is much easier to understand the potential sales cycle and whether the proposition is actually valuable to customers.
Getting feedback from real customers is a great way to understand how likely the company is going to scale.
3.3 Are there any customers providing revenue?
If the startup has an existing product, the next question is whether they already have real paying customers and revenue. Of course, this is not a deal breaker, as early stage companies have rarely reached this stage before approaching an angel investor.
If they have, it is a huge bonus. If they haven’t, they need to have a plan for getting their first few paid customers.
3.4 What is the quality of the startup team?
The leadership team of a business will only be able to execute plans successfully when there is a strong team around them. You need to assess the quality, capability and experience of the whole team, look for any gaps or obvious weaknesses.
One of the biggest issues that all startups face when scaling is being able to hire quickly enough while maintaining quality. Therefore you should look into how they have hired to date, what quality of candidates they have found, and whether you think their hiring will scale.
4. Go to Market
4.1 What is the business’s unfair advantage?
What are the odds the startup will succeed? How are they going to cut through the noise of all the other businesses in the market? This is an area I place a lot of weight on in my screening criteria.
Founders with successful startups often have an unfair advantage:
- Google had strong Stanford connections, with access to talent in algorithm-writing engineering.
- Facebook launched while Zuckerberg was still a student and had a deep understanding of campus culture and directories.
- Mary Gates was closely connected with the CEO of IBM, which led to IBM hiring Microsoft to build the operating system for their first personal computer
Sources of an unfair advantage could be:
- Access to talent / skills.
- Network and relationships.
- Deep experience in an industry or business segment.
- Proprietary intellectual property.
- Joint ventures or partnerships.
Another way to look at this is what gives you the edge to beat both the existing competition and any fast followers in your business?
4.2 What is the state of the competition?
Every business idea you see will have competition in some form. However, if you are looking to enter a segment that Google, Facebook and Apple are already in, then you are likely to have a tough time.
Some competition is good, it shows there is a market available, but competition from very large competitive companies can make it difficult to get traction.
However, if you have a strong unfair advantage, then you might be able to thrive, even in a tough market. If you are successful in a difficult competitive market, then there will be many opportunities for acquisition from these larger competitors.
4.3 What is the quality of the positioning strategy?
Having a deep understanding of the customer needs and their pain points is a good first step to crafting a positioning strategy. This needs to be designed in the context of the existing competition in the space.
What problem is the business trying to solve and how are they going to stand out from the competition? Are they going to compete on: Price? Quality? Features? Novelty? Access? Or a different Unique Selling Point?
4.4 How will the business sell and acquire customers?
Even in early-stage businesses, it is important the founding team knows how they will sell and acquire customers. Unfortunately, the startup world is littered with companies that own great products, but could not work out the right way to sell them.
Having a clear strategy of how the startup will identify, target, sell, and keep customers is a very important factor in success.
If the business has already made some early sales then you can examine these to see if this sales strategy will scale, and how much effort it took to close the sale.
5. Financials
5.1 What does success look like for financials and customers?
Getting aligned between the startup founders and investors on what customer, revenue and, margin targets should be for the next 12 months is very important.
As an investor, you will not be working in the startup day-to-day, so having some agreed targets you can track will be very helpful. It is not about achieving the targets directly but having the discipline to understand over or under performance in order to make more rapid progress in the future.
5.2 How will the business make money?
Knowing how the business will make money is fundamental to the future valuation of the business. Personally I do not invest in businesses that require huge scale before they start making money; this is best left to Venture Capital companies with deep pockets.
Knowing how to price your product, the average customer order size, costs, and margin will help you model the key financial metrics of the business. From here you can determine the number of customers you need to get to your next valuation bracket.
5.3 What will the investment be used for and how long will it last?
The angel investment will only last for so long. It is important to work out how much runway the investment will give and what is the funding strategy when it runs out. Most of the investment in an angel round will go towards paying for the founding team. Knowing the monthly spend burn rate will give you a clear idea how long the money will last.
More importantly, you will want to agree with what will be achieved at the end of the funding. Will the money be used to build the product, build a team or invest in getting customers?
You need to understand the viability of raising additional rounds of financing if progress is made.
When the money runs out and you need to raise more investment, you need the company to have made enough progress. This is reflected in a higher valuation at the next funding round.
Summary
In our current climate, more startups are looking for investors to help them succeed. If you are thinking of investing in a business, here is my personal process for screening opportunities and determining whether they are worthwhile.
Questions to consider include:
- Do the future plans of the startup align with your vision and philosophy? Will you be able to provide value to that business plan? More importantly, do you believe this idea or startup will succeed now, and is it scalable in the future?
- Do you have confidence in the founding team? Without the full commitment and effort of the team, the business will likely fail. Do they have the ability to execute the business’s vision? What is their track record?
- What has the business journey been like so far? Do they already have a viable that is making them money, or is the business at the idea stage? Without a pre-existing product and revenue stream, the investment risks drastically increase.
- Does the business have an unfair advantage that will help them succeed? What competition do they have, and does it pose a serious threat to the startups future? In the event of competition, what is their marketing strategy?
- How are you going to align the interests of both founders and investors? How is the business going to make money, and what will the return on investment be for you?
In following these tips, you can properly screen your investment opportunities as a means to determine which opportunities have the highest chance of success.