How VCs Examine Startup Teams

The human factor and its significance to a startup’s success: What do investors look at when examining team dynamics?

Co-written with Matan Bordo, Ventures Manager at F2 Capital & The Junction.

Founders like to see things through a rose-tinted lens when talking to investors. But what if things aren’t as rosy as they look?

According to Gigi Levy-Weiss, one of the most active and connected Israeli angel investors, “An excellent idea with a mediocre team would interest me far less than a good team with a mediocre idea.” It turns out that this philosophy is backed by years of research. According to 2018 CB Insights Report, “The Top 20 Reasons Why Startups Fail”, of the 101 cited cases of startup failure, two out of the top four reasons can be attributed to team dynamics (boxed in red below). However, you can attribute many of the other listed reasons as a direct result of having bad team dynamics — i.e. “running out of cash” or “burnt out” — so the percentage is likely higher.

American academic Noam Wasserman validates this in his book, “The Founder’s Dilemma”, by opening with the eye-popping statistic that 65% of startups fail “…due to problems within the startup’s management team.” In another survey asking investors to identify problems they thought might occur in their portfolio companies, 61% of the answers involved problems within the team.

I highlighted the main reasons for failure that arise as a direct result of poor team dynamics, but you can make arguments for many more. Source: CBInsights

If you ask the most influential investors in Israel how they choose their investments, they will claim religiously that the team element is the most important factor and has a dominant element in the decision making process. Gigi Levy-Weiss admitted in a lecture a few years ago that a good idea is not hardly enough to make him open his pocket and invest in a venture. According to him, 70% of his decision in whether to invest in a team is influenced by the team’s identity.

About two years ago I (Noa) was fortunate enough to meet Ruthi Simha, General Partner and Founder of the Viola Credit Fund, as part of an empowerment program for female entrepreneurs. Besides being an inspiring woman, Simha has more than 20 years of experience in technological investments and is responsible for raising 4 different funds and over 20 exits.

Each and every entrepreneur reaching Simha’s doorstep has huge technological and market potential, so how does she choose? What unique qualities does the chosen ventures possess? Simha’s answer was conclusive: The decision is broadly based on her impression of the human capital — the founding team. Simha gave me and the rest of the women in the room important insights regarding the extent to which she places emphasis on team dynamics and the individuals forming the startup team. She makes sure to identify complementary skills and professional abilities, mutual respect, strong leadership, synchronization, and communication of team members with one another, both on the professional and the interpersonal levels. According to her, only a team in which we can find all these elements, will succeed in containing the success and leverage that follows the investment.

But how exactly do investors evaluate the likelihood that the founders and teams they’re investing hundreds of thousands of dollars — even millions — in, won’t turn on each other and implode? What are the red flags to avoid as a startup? In this piece, we’ll offer two team dynamics red flags that, from our experience in working with startups, may signal to the potential investor that they should consider passing on the opportunity. Conversely, we will also share two green flags that we have found to be a good indicator that the investor has a winning team in their hands.

On March 12th, Noa will be presenting on “The Psychology of Building a Successful Startup” in Tel Aviv. To register for the event, go here.

Red Flags

The CEO isn’t leading negotiations.

Since one of the CEO’s main tasks is to lead the company in these activities, if the person that the investor comes into contact with during the due diligence phase and preliminary negotiations has a different role, senior as it may be (CTO, CMO, COO, etc.), this may represent a ‘red flag situation’. The fact that the CEO is not in the picture may indicate they don’t have the appropriate skills, that the other team members does not believe in them, or — even worse — that they carry out moves behind their back.

Either way, any of the above is likely to create trouble in the future, so it’s recommended to understand that investors look at the negotiation process as an indicator for what is yet to come. In one of the “Team Due Diligence” sessions Noa conducted with a team of entrepreneurs on behalf of an investor, the company’s CEO was not involved in the negotiation process with the investor until two days prior to signing the agreement between the parties. The reason for the CEO’s absence from the process is unclear, and all we know is that once he loaded restrictive clauses on the agreement it caused the whole deal to fall after two months of intensive negotiations.

If the CEO can’t lead negotiations with investors, you’re going to have a bad time

The CEO doesn’t present the team.

From our experience, in order to see the full picture, it is highly important to meet and examine the entire founding team. Meeting with the CEO alone will not provide investors with the essential data regarding the interactions between team members and their daily functioning as a working team. Just by observing the whole team, investors can discover crucial information regarding their ability to cope with uncomfortable situations involving decision making & uncertainty, interpersonal relationships in the team, and more. If investors feel that you are avoiding introducing them to the entire founding team, they’ll think something is off. They may feel that the CEO is a ‘soloist’ who doesn’t rush to share fame or decision-making with his team, or simply does not believe in the ability of his team members to contribute to the process. Either way, any of the above is much likely to create trouble in the future.

Investors will be wary of CEO’s who don’t appear to attribute successes to their team

Green Flags

You have a solid plan for your investors’ money.

The most common crisis point in startups, as we see it, is the moment after the funding hits the team’s bank account. That is the point when chaos can ensue and interests begin to conflict — e.g. each of the founders fight for their own cause: the CTO will want to recruit an additional programmer, the CEO will rather spend money on developing the product, the CMO on marketing, and one of them will want to get a bigger pay check every month since they have two kids to feed.

As an add-on, if the founders have invested some of their own money into their venture — or have already reached out to family & friends for early capital — this indicates to investors that they are more likely to take greater care in establishing a sound financial plan for future capital raises than those who don’t. Asking family and friends for investment can be an uncomfortable situation, and doing so demonstrates conviction in your vision. Having said that, when your team has a plan for the money and all of them are on board with that plan, it’s a solid green flag!

The founding team members complement each other, forming together the “ultimate manager”.

Dr. Ichak Adizes, a world renowned expert on organizational management & behavior, states that there are four types of managers — Entrepreneurs, Producers, Administrators, and Integrators. Entrepreneurs’ are focused on long-term results and attempts to identify new opportunities. Producers are focused on executing and achieving results in the short term. Administrators are focused on streamlining operations, with a focus on the short-term. Integrators are focused on carrying out tasks effectively, with the long-term in mind. The integrator’s main role is to create synergy between the different parts of the organization and to maintain team cohesion — key in establishing a positive company culture from the outset.

The ideal situation is that the founding team is composed of, in some variation, all four of these managerial types as a combination of those styles is optimal for making high-quality and effective decisions. Most leaders present a combination of some of these four styles, but no one — not even the most successful and talented manager — can demonstrate high and equal power in all 4 domains simultaneously. Therefore, it is crucial that your team members will complement each other with these skills and qualities, so that together they constitute the ultimate management team.

Closing

Most advice given on vetting & investing in startups tends to focus on aspects of the product and the market the startup operates in (Value Proposition, Total Addressable Market, Key Partners, etc.) but, as Noah Wasserman and the CB Insights report demonstrate, it doesn’t matter as much if the team doesn’t demonstrate a belief in each other, complements one another, and has a sound (and realistic) financial plan. While we covered our top red & green flags, we know that there are plenty more. If you have any to add from your experiences, feel free to share in the comments.

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Noa Matz

Written by

Startups Psychologist, Entrepreneur and Researcher

Power to Founders

The Life and Tactics of Founders in Israel.