As a starting angel investor, I wanted to share a few key mental models and questions I use to evaluate potential investments. I’ve listed some of the key things I think about in order of importance below. My plan is to write about new angel investments using the framework below. Hope this will help keep me honest and that it’s useful for founders who are raising angel rounds!
1 Founder-Market Fit
To assess founder-market fit, ask the question: Is this founder or founding team a great fit for this particular market? Founder market fit can manifest itself in 3 areas: 1) domain expertise, 2) a mission-driven mindset, and 3) technical skills. In a dream scenario, a founder or founding team has all three or the ability to develop all three relatively quickly. I’m somewhat biased towards founders who are mission driven, as founders who care deeply about a problem will often demonstrate more resiliency in the future (and resiliency is probably one of the key factors that determines entrepreneurial success). Furthermore, technical skills can be a necessary condition to be successful in some markets that require very technical solutions. Finally, the most nuanced one is domain expertise as it can be very helpful to break into certain markets, but too much domain expertise can sometimes hinder innovation.
2 Product-Market Fit
According to Marc Andreessen, “Product-Market fit means being in a good market with a product that can satisfy that market” or in the words of Eric Ries it is defined as “the moment when a startup finally finds a widespread set of customers that resonate with its product”. Whatever the definition, it’s usually easy to tell whether a company has Product-Market fit. When you don’t have it: your customers aren’t very happy, word of mouth isn’t happening, usage isn’t growing, the sales cycle takes too long, and too many deals don’t seem to close, etc. When you have it, it’s smooth sailing and hiring the right people quickly becomes the biggest barrier to growth.
3 Product-Channel Fit
Brian Balfour wrote an incredible post on this too-often-underestimated crucial aspect of startup success. It builds on Peter Thiel’s insight that when it comes to growth: “The kitchen sink approach doesn’t work. Most companies get zero distribution channels to work. If you get just one channel to work you have a great business. If you try for several but don’t nail one, you’re finished. Distribution follows the power law.” In the context of angel investment, I try to answer the question: Has this company found at least one channel that works for the product, or is the product very likely to work well in at least one channel? If neither is true, it may be an issue and the question becomes whether you have faith in the team’s ability and resilience to keep iterating till they get the product to work for at least one channel.
4 Model-Channel Fit and Cash Flow Dynamics
First, what do we mean by “Model?” The two most important elements of your model are:
- How you charge — For example, free (monetized with ads), freemium, transactional, free trial, one year up front, etc.
- Average Annual Revenue Per User (ARPU) — The average amount you make from a customer/user per year.
Model-Channel fit then determines how well your ARPU matches with the costs of your channel. If you have a low ARPU (examples: yelp, craigslist, wikipedia, facebook, ..), you need to find a fit with a low-cost channel (SEO, virality, ..). On the other hand, if you only have channel fit on more expensive channels (enterprise sales, b2b inbound, ..) this has to be matched by a sufficiently high ARPU, or it just won’t work. The definitions above are borrowed from this post.
Model and Channel interactions are key determinants for the cash flow dynamics of a startup, and by consequence, heavily influence the amount of money a startup needs to grow. As cash is king in the early days of a startup, it’s one of the areas I love to dig in to understand well.
5 Investor-Founder Fit
This is the most simple and subjective one:
1) Do the founder and I think I can help as an angel investor in some way?
2) will I care to do so? and
3) is the founder open to feedback?
This is the start of my journey as an angel investor and I plan to share learnings by blogging and on twitter.