This is what investors look at when investing in a startup
From the 4 P’s to the 4T’s
I’m often asked what do angels and VCs look for in a startup, why did that company with the same idea raise $3m and I’m being told I can only raise $300-500k on a $3m valuation, and how do I value my company pre-product/pre-revenue/pre-PMF (product market fit)? So today I want to share what a VC looks at when we receive a call, go through a deck, or attend a demo day. This article will be followed by others going into more detail.
OVERVIEW
There are 4 things that an investor looks at when evaluating an investment. While there is some variation in the order of the qualities below that an investor values and looks at, this list summarizes the vast majority of investors. A 2016 study that looked at 885 VCs concluded that Team was the dominant first quality that a VC looked at, confirming a sample/study conducted in 2013. That being said, many of the best investors in the world look at the market/timing/industry (with the strongest proof being that there are funds with theses on a specific space: web3, SaaS, fintech, etc.). The 4th attribute is the wildcard: it varies between pre-product launch (what’s the GTM, network, etc.) and post (traction/growth/sales/users), and can be anywhere from first on the list to last.
Team
Market Size / Timing
Idea
GTM / Traction
At the angel / pre-seed (and sometimes seed) stage, investors look at the 4P’s - (in order):
People (Team)
Potential (Market Size/Timing)
Product (Technology)
Plan (GTM strategy)
At Series A (and sometimes seed) and later, that list evolves to the 4T’s - (in order):
Team
Timing (Potential) / TAM (Market Size)
Technology (Plan)
Traction (the wild card) I’ve seen traction be the #1, #2, #3, or #4 most important thing on the list.
IN DEPTH
Let’s go through the rationale of the list:
1. People / Team - Why you and your team (i.e. why are you the right person/people to solve this problem) and what experience can you point to to show that?
Team, in a sense, is everything. Companies fail because of because of teams (famously HQ, Better Place, and in fact, Noam Wasserman’s research found that 65% of the VC-backed startups that failed did so because of founder/people problems). And companies survive because of resilient and creative teams (Slack, Loom, and a really high percentage of early stage startups that have had to pivot or navigate through tough time).
I’ll focus the next piece just on teams. Know for now that the same product but a different team can make a VC say no or can make a VC invest millions.
2. Potential / Timing (Market) - Why now? What technological innovations have emerged or regulatory changed have happened that allow for this now vs not in the past? How big is the market you are addressing and how fast is it growing?
Market means to investors: POTENTIAL. VCs want to find unicorns and the market needs to be big enough to make that likely. There’s a big difference between the multi trillion dollar real estate market and a $100m niche industry. We also care about how fast the market growing. A market growing at 7% a year will be twice the size in 10 year, giving the company more market to capture.
Lastly, market includes competition. How competitive is the space, how hard is it to enter or grow within the industry, etc.? This is the traditional Porter’s 5 Forces / PESTLE / SWOT analysis/ Blue Ocean-Red Ocean (or any new cool MBA framework). It looks at your ability to succeed in the market and how defensible of a moat you’ll be able to create.
After a more thorough analysis on team, I’ll write more on Market. Market is incredibly important as it can decide whether or not a company is venture-backable. To many investors, timing is the most important consideration because a product can either succeed or fail due to timing.
3. Product / Technology - How important/acute is the Pain you’re solving, how disruptive is the idea, how developed is your product (& is there defensible IP).
Entrepreneurs fall in love with their idea (trust me, I know, I’ve been there). They eat, drink, sleep, bathe, dream, and wake up to their product. A visionary entrepreneur has thought of the the MVP, the beta, the full product in 3 years, and then how that product will develop and encompass other products and features and evolve into the mythical unicorn.
Why we value product: products solve problems and people buy solutions; products are brands and consumers and enterprises buy into them; technology is scalable which means success will build on more success (without the need for infinite expenses); products are original, have a competitive advantage, and can disrupt industries; lastly, technology can be defensible and have protected IP.
Why it’s on the bottom half of the list: It rarely works the way the founders imagine! It often takes years to develop the product that users love. And there will be pivots and adjustments along the way pre and post PMF. Here are 8 legendary startups (including Slack, YouTube, and Shopify) that didn't begin at all as they do currently as household names.
4. Plan / Traction - How are you going to build and execute? What is your GTM (go to market) strategy? How much revenue are you generating? How fast is revenue growing? If pre-revenue, how many active users do you have? How fast is your user base growing? How engaged are those users? What is your CAC (cost of acquisition)?
Plan - pre product or revenue, investors want to know how you’re going to get the first 100 users (or 10-100 customers) that love your product.
Traction - the later the stage, the more important this becomes. In fact, it can be the most (or all) important factor for investment. Traditional investing and valuation is based off of DCFs (discounted cashed flows) and traction is what gives us the detail of current performance and confidence in a company’s future success. Investors want to know how their money will impact traction, and if a cash infusion can help produce the hockey stick curve of exponential growth.
We’ll go into GTM strategies and traction/growth metrics in the future.
Hope this was helpful.
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I’d love to hear your thoughts on this beginning overview. Please leave a comment below if you have something you want to share.
Great read!