The Four Main Things that Investors Look for in a Startup

Posted on Oct 6, 2010 | 64 comments


I obviously don’t speak for all investors.  But in my experience as an entrepreneur and now spending my time amongst investors I can generalize that almost all VC investments in early stage technology & Internet investments come down to just four key factors.  And they’re easy to remember because they all begin with an M: management, market, money and above all else momentum.

This post was prompted by an email exchange I had with a young entrepreneur.  It’s a conversation that creeps up from time-to-time.  This person had been introduced to me several times by angels and I was told that I’d be the perfect seed investor.  I was interested in learning more.  For a combination of reasons I didn’t end up talking with the CEO in time and the company quickly became over subscribed.  That’s fine.  It is probably the right thing for the stage of company.

So I wrote to the entrepreneur and said, “Congrats. Now that you’ve gotten the round done I’d love to get together at your convenience and learn more about your business so I’ll be ready well before you’re next fund raising event.  The CEO said, “Not taking meetings with investors for a while (hope you understand), so lets connect again in a few months?”

I do understand.  And the CEO was very polite and professional about it.  And the fault for not meeting quickly in the first place was mine.  I had been traveling.

I understand.  But I disagree with the approach for most entrepreneurs.

Not everybody agrees that entrepreneurs should take investor meetings outside of “funding season” when they’re raising capital.  They see it as a distraction and a time suck.  I agree that you shouldn’t take tons of meetings and not from people who are just “fishing.”  But I believe you need to identify those investors that you think will be a good fit down the line and start building your relationships now.  Maybe this CEO doesn’t see me as a great fit.  That’s OK, too.

But if you identify investors with whom you’d like to work here’s my advice:

1. Momentum - The number one thing that investors get their checkbooks out is for momentum.  Everyone has their own definition of momentum (user numbers, revenue, channel partners, biz dev deals, whatever).  But the reality is that this nebulous term people talk about that they “need to see traction” really just means that they’re not ready to invest in your company. Why?  Chances are they don’t know you well enough and can’t judge your performance or capabilities.  Some have “rules” – everybody breaks them for the right deal.

Imagine the “typical” deal – somebody comes into a VC’s office, they’ve never met, they’re highly referred by a friend and they’re pitching a product demo and a PPT.  You’ve never met them and are asked to make a judgment in 2-3 weeks because they’re doing a road show.  That might work for $50-100k but less likely for $3m unless you’re a seasoned entrepreneur, known to the VC, have some metrics that work in your favor or have built something the VC believes to be truly unique.  And VC’s are tough customers.  They’ve “seen it all.”

So that’s why I tell all entrepreneurs that if you want to raise money from VCs you should see them early.  If I see your alpha product then I can judge how it develops over time.  If you have 2 developers and the next time I see you it’s a team of 6 with a new head of products I can see momentum.  If you have beta customers, new pricing plans, different positioning, more market insights, good press coverage – whatever – these are all signs that the ball is moving forward.  And it is that momentum that is easier to judge than a single data point.

Some entrepreneurs have said to me, “yeah, but then the VC sees you when you’ve not yet matured and you set a bad initial perception.”  Not if you manage expectations.  ”We know that we’re meeting you earlier than you’d normally invest.  We therefore may not have the full progress you’d expect but we’d like to meet you early so that when we’re at the stage you normally invest you’d have a chance to judge our progress.”  Lowering the bar is disarming.

So imagine when the entrepreneur who “isn’t taking investor meetings” comes back for the next funding round.  It’s true that I’ll have points A & B.  But I would have missed a lot in between. And my “point A” is only determined by what I read in the press since we never had our initial meeting.  If the company “crushes it” and has data to prove they’re doing well I suppose it hardly matters.  But if they’re like most people it’s harder to measure.  Almost every deal I’ve ever funded I’ve gotten to know the founders over time.  I’ve talked before about how to build long-term relationships with VCs.

2. Management Team - This is really a sine qua non.  Different VC’s have different calibration points on the continuum of management, product or product / market fit.  I’m personally 70% management, 30% product.  But for any investor it takes a miracle to get investment dollars out of them if they’re not impressed with the team.  You will find some investors who will say to themselves, “I could do this deal but the CEO will need to be replaced.”  Sadly, I hear that all to often.  I never feel that way.  If I feel a priori that the CEO can’t cut it I’m highly unlikely to invest.

Because management is so important I always tell people to make the bio slide the first in your deck.  If you have good experience then the VC will be leaning forward for the rest of the presentation.  If you save the punch line that you’re from the industry, did CS at MIT, worked for 3 startups, whatever, then they don’t have that powerful knowledge as part of their evaluation set.

If you haven’t read my post on the bio slide before here it is.

3. Market Size - There is a lot of talk about “dip sh**” companies these days.  Mostly by early stage investors talking about getting smaller exits.  But whether you’re talking with micro VCs, seed stage investors or series A,B investors they all want to believe that your company CAN be big one day.  They might want you to start lean.  They might accept that a $50 million outcome will drive good returns given their small investment size, low price of entry, etc..  But almost all VCs care about investing in big markets with ambitious teams.  So NEVER talk about early exits, quick flips, tuck-in acquisitions, previous interest shown by acquirers, etc., during your meeting.

And make sure you have some metrics or some way of demonstrating why you believe this is going to be a really big market.  As I’ve said before, “sorry guys, it’s the size of the wave, not the motion of the ocean.”

4. Money - The final M is often misunderstood.  Most VCs you’ll want will want to be able to put a certain amount of money to work and will want to own a large enough percentage of your company to pay attention.  There are modern investors who think differently and are willing to invest $100k as part of a $1.5 million round.  But mostly when they do it’s just because they consider you part of their early stage investment portfolio where they’re less sensitive about ownership percentage.  If you “take off” they’ll likely want to own more.  I acknowledge that some investors have as their strategy to make lots of small bets.  It’s the exception rather than the rule.

We can have an intellectual debate about whether it is the right investment strategy or not to have a minimum threshold.  I’m only here to tell you that it is the case and better that you know going in.  Most VCs want to own between 20-25% minimum of your company.  If they co-invest with somebody else that they consider important they might be willing to cut that back to 15%.  But most VCs won’t want to own 8% of your company.  If they do it’s likely because they want an option to invest more later.

I’ve heard one prominent investor talking about how one of his best returns he only owns 7-8%.  But that’s because it turned out to be a $2.5 billion company (and counting).  So if you turn out to be THAT then people will be happy with just 2%.  But for the 99.9% of everybody else know that VCs will likely allocate their time more to companies with higher earning potential over time.  Don’t shoot the messenger.  It just is.

And by the way, it’s OK to ask, “do you guys have a minimum ownership level that you like to hit?”  Doesn’t hurt to politely get this out in the open.

BUT WAIT? All these “m’s” and you never spoke about product?  WTF? What about Product / IP?  That’s not an M?  OK.  True.  It’s a P. But to make the 4 things more memorable (and thus all M’s) I had to wrap product up in momentum, which is mostly based on product momentum.  But to be clear: investors care about management, markets & products.  They invest in deals where they can own enough to make it worth their time  - thus “money.”  And all of this is wrapped up in forward progress that you demonstrate over time.

Investors invest in The Big Mo.

  • http://coursehorse.com Nihal Partha

    Mark – great post (and I love the use of sine qua non!).
    I have one question – can first time entrepreneurs overcome short resumes with traction / momentum / an incredible pitch?

  • http://coursehorse.com Nihal Partha

    Just went back and re-read 'The First VC Meeting'.
    It sounds like you're saying that pitching your own credentials is just resume building 101 – to tell a story around what relevant experience you do have in a compelling, selling way.

    Also occurred to me that every startup pitch needs a 'here's what we do against those godforsaken Stanford grads', regardless of the credentials of the founders – nice tip!

  • Matt_ackerman

    Great information.

  • Barry Peters

    In all my years of trying to find funding for one of my projects, I've concluded that “creative idea people” such as myself, rarely have either of tow things; money to fund their own project, and credible sr. management experience that an investor is looking for.

    Thus, I would conclude that becaue of your industry's practices, the best products very seldom make it to market because the people with the ideas for those products never get funded. I look at that mindset as completely ludicrous.

    If I were an investor, I'd want to hear about these amazing products from people who are engineers, designers, etc (capable of building a functional prototype). Then, I'd find the management team to place around them. Let people do what they do best. A creative product developer will seldom already be a great CEO candidate; why have such a limiting restriction. How many CEO's were directly responsible for creating the products that made their companies great (less than 5%???

    VC's, angels; you guys need a more effective strategy if you want to get the most for your money. I've got at least 4 projects that are over 15 years old that have yet to be introduced to the world by anyone else, on 3 different levels of revenue generating potential. Any of them would be a worthy invvestment. However, because I'm not an experienced “executive-level manager”, I've never been able to be considered a viable candidate for an investor. That's got to be the most bass-ackward thinking I've ever heard.

    Give me just one serious angel investor to build any of my prototypes, I'll consider any reasonable management team you want to build around me (I'll take the CTO position since I have 25+ years of combined technology experience). I'm confident that within less than 18 months, I'll have a prototype design that's ready for production and enough product interest from potential customers (B2B and B2C) that will make investors line-up around the block to invest in the next stage of financing.

  • Rhmayo

    Mark Thank you for your providing the clarity of thought for VC investing. I wish more VC's were able to articulate as succinctly as you have been doing in your blog. Many of them do not practise what they preach and wind wasting valuable time for investors.

  • http://hirethoughts.blogspot.com Donna Brewington White

    Mark — Lurking around VC blogs, the message has come through clearly that the management team factors prominently into the VC decision. However, I've known enough startup founders to know that they can be truly brilliant in terms of technology, product, marketing, etc., and not be adept at recruiting a team. I'm thinking pre-investment, since the resources and recruiting options expand after funding — not to mention the help some portfolio company's receive from the VCs themselves in making strategic hires. Is pre-funding recruiting/team-building something you might address in a future post — to give pointers to aspiring entrepreneurs? (Or, maybe you have and I've missed it?)

    Also, who are the critical players that need to be in place in order for you to feel that you can adequately assess the management team? By management, do you mean founder/CEO or are there others that are critical to the investment decision?

  • http://hirethoughts.blogspot.com Donna Brewington White

    So he's teachable/coachable! That's a great sign.

  • http://hirethoughts.blogspot.com Donna Brewington White

    VC's Aren't ATM's — Reece that's brilliant — clicking there next!

  • http://reecepacheco.com reecepacheco

    thanks!

  • Creative_Ideas

    I completely agree with your points. It seems that “Venture Capitals” are not so adventurous nowadays. For people with creative ideas but without management experience or a management team, if you can bootstrap to a point where VC's are willing to fund you, then you may have already reached a point where you do not need any VC's. It is ridiculous indeed.

  • http://www.justinhong.com Justin Hong

    Hey Mark,

    Thank you so much for this informative post. It's very helpful, especially for an entrepreneur like me who hasn't had any experience with seeking outside funding. Your tips about meeting with VCs early if you're trying to raise money and putting your bio slide first are are especially insightful to me — never would have thought of those things on my own :). I look forward to reading your blog and learning more from you!

    Justin

  • Peter

    Hi Mark

    “How I learned to laugh in their faces”

    Or “Where are the Non-Tech Angels”

    Your blog’s universal lessons help but allways point to tech.

    After founding 3 companies and co-founding 3 others I finally have the perfect business. It fills market voids, has sales history, few employees, is domiciled anywhere, outsources operating risks, is profitable at 16% capacity, and has no debt.

    We’re not tech, bio or renewable. We build quality products with 25% a price edge; thriftier running costs, more comfort and safety, plus broad appeal that together scream “Competitive Advantage.” We bought, and then improved the IP of a successful overseas boat builder with competitive moats and a margin protecting “new way” to build it.

    I have a potential 18 bagger, sales history, track record, team and product, yet no one looks my way simply because we’re not in the crowded tech or bio universe. I don’t get it.

    Can anyone you know direct me to non-tech angels? They must be out there. Please help me.

    Peter Tucker peter@coastalcats.com 1-360-808-7080

  • http://www.google.com/profiles/dreyemi Kayode Odeyemi
  • http://twitter.com/tpastushkin Timothy Pastushkin

    Mark, enjoying your blog and articles on Techcrunch. We are working on a new project that I would like to present to you. Would it be possible and, if yes, what would be the best way to contact you? Don't want to write about it here to not look like a spammer :)

    Thanks!