It’s important for founders to understand the way investors think about startup investments. There’s no clear-cut answer, but after analyzing several hundreds of companies over the course of our collective careers, we’ve come to the conclusion that investor pitches are often sub-standard. It’s unfortunate because the project would actually be considered compelling had the presentation been more polished and well-communicated.
The number one question an investor asks himself or herself in the first 30 seconds of your pitch is “Is this going to make me money?” By that, they don’t just mean some money but a lot of money, many times more than what they had invested. What one needs to keep in mind is that an early-stage investor (i.e. individual angel or Seed/Series A venture capitalist) is investing in ideas, teams, and products that do not have an abundance of financial data to work with. As such, the evaluation tends to involve less number crunching, and rather, more qualitative analysis. That’s not to say that numbers don’t matter — they very much do, especially as it pertains to potential market size and customer KPIs. However, it’s difficult to get precision forecasts when you don’t have a trove of historical financial data to work with (the way sell-side equity research analysts do). As a result, investors think about your startup holistically and there isn’t a cut and dry formula.
Because this post is meant to be an introduction, we will paint with broad strokes first, with later posts focusing on the specifics of given areas. Here are some of the main categories investors evaluate when looking at your startup, in no particular order: 1) Problem and Solution, 2) Unique Differentiators, 3) Market Size, 4) Team, 5) Traction, 6) Financials. This list is not meant to be comprehensive. As such, it doesn’t include everything, but rather the primary takeaways one should consider.
Problem and Solution
The problem is paramount and you should think long and hard about your problem and why it’s important. The problem needs to be one of the first things articulated and should be crystal clear to the investor within a few seconds.
The solution, in a more general sense, includes a sense of what the long-term vision is and how your solution addresses the problem.
The differentiated value proposition and unique aspects to your solution can be thought of as an after-point once the solution is articulated. Even if the solution addresses the problem, it’s very likely that there are competitors or existing alternatives that also solve the very same problem that you are solving. As such, the million (or maybe billion…) dollar question then becomes, “why you?” Why would a customer want to use you over anyone else and what is going to compel them to buy your product? A few things come to mind:
- Quality of product or service
- Specificity of target customer base (i.e. by geography or industry)
- User experience (check out our blog post UI/UX Blog Post — while we wrote it in the context of crypto at the time, it’s relevant to startups on the whole)
- Customer service
While the goal is to ideally be optimal in all aspects, it’s feasible to focus on a few and try to emphasize those points. For example, if your unique selling point is the quality of product, then you want to make sure that the quality there is 10x better than anyone else’s. However, as a result of that, you have the luxury of not worrying too much about quoting the best price (take Rolls Royce vs. Kia for example). Or perhaps you’re doing something similar to another product but focusing on a specific vertical — like ride sharing for college students, or a dating app for Jewish people. One can even have the same service as an existing alternative but excellent customer service skills. For example, SoFi resonates with the younger generation because they’re not just a lending institution with a buttoned-up, bureaucratic culture. They value customer satisfaction — case in point, they will go as far as to pause a loan and help a customer find a job if they get laid off. That kind of customer experience would have been unheard of even a decade ago with the big banks. Whatever it is, it’s important to highlight and bold the unique selling points of your product.
This is an obvious but often overlooked component by many founders. From a top-down perspective, the potential market needs to be big enough that your company can scale and acquire a large user base, which would in theory lead to large revenue and monetization. Even if the problem exists and the solution is unique, the market could still be too small to be worth it for an investor. For example, if you’re trying to sell educational software that teaches the Mongolian language to Brazilians, there would probably be a smaller market opportunity there than if you were to sell educational software that teaches the English language to people in Japan. The market size should be quantified wherever possible and it should be clear why your product is unique enough to justify a slice of that market.
We wrote a post on how to evaluate a team, so we won’t go into too much detail rehashing it, but we’ll layout the important things to consider when thinking about your team. The team is one of the most important things an investor looks at when evaluating your startup and they want to make sure that they are investing in the right people. Even if the idea and market is mediocre, a solid team can make the necessary adjustments to realize what they’re doing wrong and pivot in the right direction if they’re smart enough, nimble enough, and have the right experience. However, a bad team will lead to personality clashes, poor execution, and eventual failure of a company even if the idea and market is right. You want to highlight the skills that your team has and answer the fundamental question “Why are YOU the BEST founding team for your particular company or idea?” Essentially, you want to be able to answer this question in a heartbeat if anyone asks.
Things to market include:
- Domain knowledge
- Intellectual property
- Previous entrepreneurial experiences (successes are obviously golden but failures are still worth highlighting if you grew and learned from the experience)
- Years in the field or at prior companies in a similar field
Personality, however, matters a lot and investors will judge you on the following:
- Confidence in tone
- Presentation skills, which may indirectly correlate with sales and marketing skills
- Collaboration — do you hog the limelight or do you delegate to team members and let them speak?
- Nimbleness — are you stubborn and bull-headed on your idea or are you open to feedback? This is tricky because you want to find the line where you’re not too much of either. Being too stubborn implies that you’ll never pivot and you’ll be so gung-ho on your idea even if it ends up being invalidated by the market. However, a “yes-man” is not likely to try hard enough and may change course too rapidly before gathering enough data to find out. Patience is also a virtue in startup land and many problem-solution or product-market fit problems just take a matter of time and repeated iterations.
Ideally, there is some traction and KPIs to report. KPIs are unique to every company, which makes it hard to generalize. For example, Uber might measure some of its KPIs to be average ride cost, average number of rides given in an hour, etc. An enterprise sales software company might include average number of leads to average close ratio as a metric. The more metrics there are, the more quantifiable the rest of your pitch becomes, which makes any assumptions and numerical forecasts more believable. Traction includes having some early customers, ideally paying, although even having a pilot program and some customer LOIs are also good validation. Generally the later the stage the investor, the more important traction becomes. Almost nobody these days invests in “ideas on a napkin”, but there is a spectrum for what investors are looking for in terms of traction or milestones achieved. The earliest of investors like angels and accelerators may invest off of a strong team with an MVP and some LOIs, whereas a seed investor will want to see definite traction with either a large user base that has the potential to be monetized or a smaller customer base that is already paying some revenue. Additionally, Product-solution fit should most certainly have been achieved but the company may still iterate and pivot a bit. Series A investors will take it a step further and look not just for traction but product-market fit, where the focus is really on hiring for growth and scale.
Tying into traction, the more numbers there are available as it pertains to number of customers, revenue, and price points, the more believable any forecasts will be. An attractive opportunity for an investor will be one that has the potential to return 5–10x her money, given that she assumes some will not return much and that some will actually fail. As such a $1 mm investment from an investor for 20% post-money equity would imply a $5 mm valuation. An investor would want to see at least $5–10mm in money returned to him upon liquidation for your company to be attractive in his eyes. As such, you would want to paint the picture that you could achieve a $25–50 mm valuation, at minimum, within a few years. This is where you can find the line between being optimistic but not so unrealistic that it’s unbelievable. The latter is another problem commonly witnessed and investors often throw out decks where the financials seem absurd — they assume the management team is inexperienced and has poor financial acumen.