When I first started as an Associate in Venture, I couldn’t understand how to quickly evaluate a seed-stage company, which was often pre-revenue and sometimes pre-product.** Despite having limited data to rely on, or metrics to evaluate, it seemed easy for my colleague Matt to look at a 15 page pitch deck and immediately hone in on the key points and whether it was a ‘yes’ or a ‘no’ to taking this company to the next phase. He could also immediately tell where we’d need to focus efforts in due diligence. He didn’t use notes, and almost did it with his eyes closed.
Some of this was what Daniel Kahneman would call heuristics or ‘thinking fast’, using learned bias based on experience and instinct. However, Matt’s judgement also came from rapidly running through a set of questions in his head. An investor friend calls this parallel processing (using emotional intelligence or instinct) vs linear processing (using multiple questions).
I believe as an investor you need a balance of both, partly as the latter helps to reduce (unfair) unconscious bias.
Atul Gawande has shown how well-designed checklists (or frameworks) can improve decision making outcomes. They have also been shown to help reduce unconscious bias and level the playing field for underrepresented founders (for more on how to manage this see ETF’s brilliant investment decision making paper). I’ve recently been thinking about making better and fairer decisions through improved processes. I wanted to share this framework for seed investing that is the output of this thinking.
So below are the 10 key areas that I focus on in seed stage businesses. Some of the questions are first-meeting questions (marked with an *) and some are later stage DD questions.
One big caveat to this list; no company will have answers to every question. If you don’t have all of the answers it doesn’t mean you shouldn’t apply for seed VC funding. This applies particularly to women, who tend to count themselves out of opportunities unless they have 100% of the answers or attributes. Hopefully these questions are simply useful prompts of things to think about before speaking to VCs.
- Problem — what is the problem?
- How big is the problem the company is solving?*
- Is the problem real and validated by customers?*
- Is it a vitamin (nice to have) or a painkiller (must have)?
2. Solution — what is the technology solution that solves this problem?
- Are the founder[s] well-placed or uniquely qualified to come up with the solution?
- Is there evidence that customers like it?*
- Is it % better, faster or cheaper than what else is available?
- Can it scale globally?
3. Market — which market does the company operate in?
- Is the target market big enough to enable this company to grow to a multi-billion £? (most pitch decks will say they are tackling £bn markets but what is the truly addressable market size)?*
- What are the dynamics of this market? Is it crowded? Sluggish? Fast growing?
- Why now? Is this the right time for this market to change or new entrants to emerge? Eg. is there a major shift happening on consumer behaviour/ enterprise buying behaviour/ regulation that can be taken advantage of?
- What’s the ‘go to market’ plan to take advantage of that? Is it credible?
4. Business model — what is the (proposed) business model?
- Are the projections & assumptions in the business model realistic? Eg. for a consumer marketplace business, a high AOV is crucial if the number of purchases a year is going to be low and CAC is high. Can we test these assumptions?*
- Are there network effects baked in to the business model (i.e does the product get better with more users)?
5. Funding requirements — how much does the company need and what’s a fair price?
- Does the investment fit the fund strategy (in terms of ownership, stage, cheque size) and can our fund provide the capital that this company needs?*
- What’s the right entry price or valuation? I.e can we own enough of the company in exchange to generate meaningful value for our investors on an exit? That usually means we would need to reasonably believe we could own ~15% on an exit, so we would have to estimate how much more capital the business requires and ensure we have enough follow on funds to hold our pro-rata.
- What are the subsequent funding requirements? Do we know which funds are likely to do those rounds and can we gauge their interest now? Is there financing risk?
6. Value creation — What is the value that is actually being created?
- Has the company got a patent portfolio, a piece of defensible technology, a unique data set, or a team with unparalleled expertise (known by some as an ‘edge’)?
- Have the company built a community of early customers or advocates who are driving above average engagement (for example, Facebook at Colleges in the US)? *
- How much value can be captured from the solution? Eg. how much will customers pay for it ? For example if it is radically cheaper than existing solutions, the company will need to sell much more to generate the same value as existing businesses in the space.
7. Competition & Defensibility— how crowded or ‘red ocean’ is this market?
- Are there moats the company can build or high barriers to entry?*
- Is there a significant ‘incumbent advantage’ or an existing giant (eg. Amazon, Facebook) moving into the space?
8. Exit — who will ultimately buy this company (either M&A or buy shares in an IPO)?
- Why & when would a company buy it and does the company have a relationship with potential acquirers?
- On what metric would it be valued? Revenue/ EBITDA multiples? Size of patent portfolio? Team? Clinical / technical milestone?
- If the company was acquired, what kind of price would be paid for it? How do we know? Are there proxies?
9. Risk — a question that we ask ‘both ways’.
- What are the key risks we’d need to get comfortable with if we were to make this investment.
- On the flip side — are we taking enough risk?
- Is this company a ‘moonshot’ — i.e if it succeeded could it generate ‘outsized returns’ (Horsley Bridge data shows just 6% of venture portfolio companies generate 60% of returns)*
10. Team — the most important area to focus time in the DD process at seed:
- Does the team have a unique advantage or edge?*
- Do they have raw intelligence?
- Do they act with integrity?
- Are they mission driven and do they have a noble purpose?*
- Can they lead and hire fantastic people?
- Are they commercial and can they sell?*
- Do they understand the market and the product they’re selling?
- Do they have grit, ambition and hustle?
- Do their skills gel well as a group?
- Are they diverse?
- What are the gaps?
- Finally, are they humble and will they listen (to us, to their customers, to their employees)?
Of course, I don’t have answers to all of these questions for every company and every team, but going through this checklist is a useful way to focus on the areas that are strongest and weakest in the investment case and ultimately help get to a decision.
I tend to spend 20% of time in DD on points 1–9 and 80% on point 10, the team, which can’t be done at a desk.
Finally, the above checklist doesn’t go into detail about the metrics I would want to see for different business models, or sector specific considerations, but other posts and writers that we have found helpful are:
- Thomas Tungz on SaaS Metrics
- Sarah Tavel Frameworks
- Andrei Brasoveanu on KPIs that matter in marketplaces
- Andrew Chen on How to calculate CPA for your freemium start-up
- a16z’s guide to metrics in start-ups generally https://a16z.com/2015/08/21/16-metrics/
- John Spindler on Learning to invest in ML start-ups
- Bradford Cross on Vertical AI Start-ups
- Yannick Roux and Stefano Bernardi on the Token Economy
- USV’s Thesis 3.0 by Rebecca Kaden
- Jerry Neumann A Taxonomy of Moats
**When I started in Venture I couldn’t find a good evaluation framework beyond the standard product, market & team. I’ve since found great frameworks from Mike Maples, Jerry Neumann and in Tren Griffen’s book, A Dozen Lessons for Entrepreneurs. They are all worth reading.
If you are building a tech company with global scale and you are at an early stage, I’d love to help. Please get in touch on Twitter or LinkedIn. Please share any comments and thoughts on this, and check out Lessons from 2.5 years as a VC associate for more thoughts on seed investing.