Sieving the Seeds: How this Early-Stage VC Screens Startups

From our count, M25 is one of the most active seed investors in the Midwest with 23 new portfolio companies in 2016. That may sound like a lot, but it’s a small percentage of the myriad of companies M25 has reviewed. How do potential companies stand out? Victor Gutwein, M25’s managing director, outlines the top four components to their proprietary scorecard.

There is a lot of subjectivity involved in a VC’s job, particularly in the earliest stages of venture investing. While it may be tempting to rely solely on pattern-matching and instinct to create investment decisions from the web of uncertainty, we’ve forced ourselves to look to the available objective data points. In doing so, we’ve created an analytics-oriented scorecard that compute hard numbers driving our yes-or-no funding decisions. Each category in the scorecard has several sub-variables previously correlated with the success of startups; we use these to prioritize our investments in higher-probability companies. I’ve summarized our top four categories (by weight) here:

Team: The proverbial jockey.

  • Balance — We look for a variety of skills, backgrounds and responsibilities on the core team. Teams of all-MBAs or all-engineers perform worse.
  • Experience — Industry experience, startup experience, business experience, technical experience. More is generally better.
  • Network — How connected are the founders, advisors and board members? What networks can they call on (schools, corporations, accelerators, etc.)
  • Dedication and Passion — Are they full-time, 100% committed, or is this a side-job for an aging executive? Do they have charisma and can get others engaged?

Market Opportunity: How big is it actually? (Or, “Size matters”)

  • Size — That’s great that you’re in transportation/housing/healthcare, but what is the actual TAM? We calculate that by multiplying what you’ve demonstrated you can sell your product for by the number of customers in the market(s) you have current customers in. No hypotheticals here.
  • Growth — Is the market you are in growing or shrinking? How fast is it growing?
  • Competitors — We’re reviewing both the entrenched dinosaurs and the new startups here to eat everyone’s lunch.

Product and Innovation: Must be better than sliced bread.

  • Product Quality — How well-built is the current product? How will the product evolve?
  • Defensibility — What is your avenue to defensibility (IP/network/stickiness/exclusivity/etc) and how strong is it?
  • PMF — What actual value is being provided compared to the primary alternative? What are the customer segments and are they validating your value?
  • Innovation — Is this new or another iteration of a trendy, over-used “Uber-for”? We want products that are different and unique.

Traction: Actual customers > projections.

  • Tangible revenue — Money in the bank, month-over-month, is what we’re looking at. Money you expect-to-have in a week or month or two isn’t valued very highly when it’s coming from a seed-stage startup.
  • Margins and type of revenue — Recurring is gold; non-recurring or “service” revenue counts much less. Margins are important and impact scoring and valuation significantly.
  • Other forms of traction (users, contracts, paid pilots, etc.) — We discount these forms of traction very steeply, but they are important nonetheless.
  • Growth — How long has it taken for you to get to this point (since you’ve been in the market)?

One thing we stress as a team is that this is a holistic approach, and every variable matters — including categories I haven’t covered yet such as valuation and exit opportunities. We don’t invest in startups with incredibly strong, proven teams that have only built a pitch deck. We don’t invest in half-hearted teams running a relatively successful “side-business”. We don’t invest in ultra-competitive, “me-too” businesses no matter the market size. Our portfolio companies are well-rounded startups that are objectively strong in each category we consider. And while we will undoubtedly miss out on some “winners”, we like our odds in this well-balanced, data-oriented approach.

About the Author

Victor Gutwein is the managing director of M25 Group, a micro-VC firm he founded with some family members in 2015. M25 Group focuses on seed-stage Midwestern startups in most industries. Victor is also the co-chair of the Consumer group at Hyde Park Angels. Previously he has worked in corporate strategy on a variety new businesses in retail & ecommerce. Victor has a passionate history with startups, including a vending machine business and kick scooter company, along with being on the board of the University of Chicago’s first student-run venture fund.

Victor lives with his wife on the South Side of Chicago and loves staying active with backpacking, water polo, rugby, ultramarathons, and triathlons. If he can’t convince you to workout with him though, he’ll usually succeed in getting you to try out a Euro-style board game (like Settlers of Catan) with his friends.

About M25

M25 Group is one of the most active venture capital firms focused solely on early-stage investments in the Midwest. Their objective, analytical approach has helped support their thesis and craft what is known as an ‘index fund of Midwest startups.’ M25 has already invested in over thirty companies since their inception in 2015, and continues to invest in over twenty companies each year. Their collaborative, forward-thinking approach and diverse array of investments across industries and business models throughout the region has quickly established them as a key node in the Midwest startup ecosystem.