Mon, Feb 25, 2019

How I evaluate startup investments

Early-stage investing is complex. Usually, you’re making bets on companies on sheer gut feel. It’s slightly easier to invest in companies generating revenue from day 1 on a trajectory of growth. But considering investing in companies with just a product or idea, maybe some users and no revenue is incredibly difficult.

I believe early-stage investing is more of an art than a science. Even if you have a whole lot of data and access to sophisticated algorithms for making investment decisions, it comes down to a bunch of fundamental questions.

Since my involvement with the world of venture capital has been limited to early stage technology companies, I’m sharing my personal strategy on how I evaluate such investments.

When entrepreneurs pitch me their startup ideas, I look for answers to 5 fundamental questions. Consider each question to be worth 1 point each. If I get a convincing answer, I give the founder+idea 1 point.

  1. Do the first 30 seconds of the idea sound interesting? (Good ideas should be easy to describe in 30 seconds) 1 point
  2. What’s new about the idea, aka how is it different than what’s already out there? 1 point
  3. What does the market demand look like, or what’s BIG about the idea? 1 point
  4. How will the idea become a business? (aka the core biz model) 1 point
  5. Why is this founder(s) suitable to work on the idea? 1 point

I need a 3/5 to even consider investing, of which at least 1 point needs to come from Question #1 or #2. If the founder can make it to 3 points, I’ll take a follow up meeting.

Following that, I ask myself 7 questions to evaluate whether I am a good fit to be an investor in this startup. For each YES answer to the following, I give the potential investment 1 point.

  1. Do I like the founders? Particularly, do I like the CEO?
  2. Do they seem authentic?
  3. Will I enjoy helping them making this idea succeed?
  4. Does this thing have the potential to become a $1bn+ (in revenue, not valuation) business?
  5. Are these people basic level smart enough? i.e. can they be trained to become great?
  6. Do I have the resources to give them what they are asking for in order to get to the next round of funding?
  7. Will I be able to offer them enough overall value?

I need a 7/7 for this section to be willing to invest, no exceptions. Usually, a company that scores 10/12 can be a pretty decent early-stage investment, while anything over it is an opportunity hard to come by.