A Rubric for Evaluating Seed-Stage Enterprise Startups
Making the decision making process transparent for founders
Have you ever wondered how a VC firm evaluates a first meeting with an entrepreneur to decide if they should have a second one? If only they would tell you before your meeting, perhaps you could design your conversation to better speak to their needs. Well, you are in luck; that’s exactly what we at Ulu Ventures are going to share.
Ulu’s Investment Decision Making Process
The sketch below shows the key steps in Ulu’s investment decision-making process. It also shows Ulu’s criteria for moving companies forward at each step. The criteria for the steps above the horizontal dashed line are based on the rubric described in this article.
Our purpose in sharing Ulu’s process is quite simple:
transparency is a fundamental design principle.
While a “No” is the most likely outcome of any VC conversation, it is not the true measure of a company’s chance of success or the value of the idea, team, technology or business model. It’s merely a reflection of best efforts to reach a decision given very limited time and information.
To improve the quality of our initial conversations, Ulu is making available our evaluation rubric so entrepreneurs know what we are looking for during our meeting — before they meet us. This gives entrepreneurs the opportunity to design conversations that will put their companies’ best foot forward.
Ulu has designed a rubric to guide and evaluate our first meeting. The elements of this rubric are (not in any intended order of priority):
- Ulu Fit
- Market Opportunity
- Team / Early Market Fit
- Financial Viability
- Super Powers
After our conversation, we score the elements as follows:
“+”: stands out
“ — ”: fares poorly
“ — — ”: showstopper
A completed assessment allows us to quickly compare the relative merits of potential investments. As we meet dozens of startups each month, this relative comparison drives much of our upfront decision making.
Elements in this rubric and it’s underlying criteria are discussed in detail below.
We look at four factors when assessing fit: Seed Stage, Enterprise IT, Diversity, and Based in Silicon Valley or connected to Stanford. Startups need to have at least three of the four criteria to be a good fit. We occasionally invest in startups which meet only two of these criteria, but then the bar for a first meeting is much higher on the other elements in the rubric.
Seed Stage: can mean pre-seed, seed, post-seed and even occasionally Series A. Ulu is willing to write the first and only $100k check for a brand new startup or write a $1m check in a large syndicated post-seed or Series A round. Ulu has focused on seed stage investing for 10 years. We see tremendous upside opportunity in and love helping entrepreneurs work through seed stage challenges: identifying market opportunities, navigating early product/market fit, creating business models, developing a culture aligned with values, and leading authentically, with integrity. It’s also a good fit for our fund size.
Enterprise IT: is the area we know best. The majority of our professional careers have been spent in enterprise IT and we “grok” building enterprise products, managing enterprise sales, developing enterprise partnerships, creating enterprise business models, etc. More specifically, at Ulu we like the areas of SaaS, Smart Data/Predictive Analytics, EdTech, FinTech, and LegalTech. We also like ventures that focus on voluntary (as opposed to government-prescribed), market-aligned, sustainable solutions to environmental and social challenges. Ulu tends not to invest in consumer or life sciences startups.
Diversity: is an Ulu investment thesis. It’s not a requirement as we have other investment theses, but we believe this thesis merits special attention. “While talent may be evenly distributed, opportunity is not.” Diverse entrepreneurs don’t yet enjoy a “level playing field” when it comes to venture funding. Thoughts on diversity are often counterintuitive. Venture capitalists often believe they’re meritocratic and color or gender-blind. Yet data show those very beliefs lead to a failure to recognize or correct cognitive biases. A diverse team ourselves, we know everyone’s susceptible to unconscious bias, so Ulu developed a data-driven decision process with transparent decision criteria to facilitate apples to apples comparisons among prospective portfolio companies. Instead of criticizing others for exclusion or bias, Ulu just funds awesome, diverse entrepreneurs. By recent count, Ulu entrepreneurs are 38% women, 29% minority and 19% immigrant CEOs (see here). Two of our best exits to date have been led by underrepresented minority CEOs. Many, but by no means all, of our most highly-valued companies are led by diverse teams.
Based in Silicon Valley or connected to Stanford. Ulu is deeply involved in these two communities and that helps us, as a small firm with three investing professionals, to more effectively identify, diligence, and support entrepreneurs within these ecosystems. Likewise, entrepreneurs in these communities are often able to diligence us through trusted personal networks. We certainly invest outside of these communities, as portfolio companies in Georgia, Iowa, Massachusetts, New York, Utah, Washington, DC and Southern California demonstrate, but the bar for a first meeting is higher.
Ulu looks at four factors when assessing market opportunity which are a combination of short-term and long-term considerations.
Compelling Customer Problem: means the entrepreneur’s solution addresses a top three problem for a customer with budget.
Traction: usually means customer traction (engaged users and paying customers), but it can also come in other forms. Traction is not required for us to invest, but it is a big plus. Even a small amount of traction means the product works, you’ve figured out how to sell to an enterprise customer, and your solving someone’s problem. We also assess how challenging it will be to build market traction that is credible to series A investors.
TAM: is the Total Addressable Market. It represents the total revenue potential from a product or service. To pass our filter, startups need a minimum TAM > $1B. Ulu strongly prefers a bottoms-up calculation: TAM = value / customer * number of customers. It’s fine to start in a small niche market that when dominated, allows you to move into larger adjacent markets. TAM is the sum of both initial and adjacent markets.
Focused Go-To-Market Strategy: one that effectively targets and cultivates early adopter customers. Most customers will never buy an early product from a startup. However, many will happily waste your time in sales calls. Ulu likes entrepreneurs who know how to efficiently disqualify sales prospects and prioritize their sales efforts. We also like entrepreneurs with an unfair advantage in landing initial customers and coherent plans for developing a critical mass of customers in one niche of their market before expanding to other markets. (Further reading: Crossing the Chasm)
Team / Early Market Fit
Are the team’s capabilities a good fit for accomplishing their key fundable milestones for Series A funding?
Domain expertise: In the enterprise, there are often good reasons for seemingly dumb or outmoded behaviors. A successful new solution must address, even respect, these underlying reasons. This subtlety makes it difficult for outsiders to empathize with their target market, especially when insiders can’t articulate why things are done a certain way. Hence entrepreneurs with domain expertise are more likely to develop new solutions with a high chance of adoption.
Committed team: Launching a startup takes a ridiculous amount of effort. We favor entrepreneurs who are 100% committed to launching their startup with no significant outside commitments. Founder vesting is a strong signal that the entrepreneurs are committed to the long term and willing to align interests with investors.
Fit for Early Challenges: A key milestone for Series A funding is often an ARR run rate of $1m — $2m. This requires not just sale skills, but the ability to move from pilot projects to full blown enterprise implementations. While the milestone is specific, team fit is often context-dependent. If the product is a “pain killer”, has few competitors or potential substitutes, the team doesn’t have to have stellar sales skills. If customers are not aware they have a problem or there are excellent or incumbent competitors, then demonstrated marketing and sales skills are crucial in the early team.
Entrepreneurship, at its best, is a spiritual endeavor. The aim of entrepreneurial work is to bring into existence something beneficial that exists only in “potential”. Our philosophy is that when we do right by others, trust emerges. When we work together while nurturing each other, community emerges. Trust and community are the soil in which the seeds of entrepreneurial vision, capital and effort take root and flourish. Since shared values are the foundation of meaningful relating, Ulu looks for teams that care about and share values. Given how many meanings the term “value” takes, we want to clarify three aspects of values that are important for us.
Authentic Voice: Ulu looks for founders who are comfortable in their own skin, who have an authentic voice, and who thoughtfully seek to behave in alignment with their articulated values. This voice articulates the meaningful purpose of the venture. Henry Ford said “Business must be run at a profit, else it will die. But when anyone tries to run a business solely for profit … then the business must die as well, for it no longer has a reason for existence.” We seek to partner with entrepreneurs we find inspiring in vision and character. (Further reading: What does brushing twice a day have to do with profits and impact?, Counting Meaningful Purpose with the Three Goddess Braid, )
Ethics: Ulu looks for founders who are self-aware, intellectually honest, and who proactively look to understand and communicate the “whole truth” of a situation or material information to build trust and fruitful relationships in business. We hold ourselves to the same standard, and our process is designed to be truthful. Ulu produced this article to help you know how we think, and so our decision-making process is more transparent. When truth is at the foundation of a relationship, working together is respectful, sincere and more often than not, easier and more enjoyable. (Further Reading: Ethics for the Real World)
Character: It is possible to be ethical and be a total jerk. So ethics are not enough. We value character and founders who embody “servant leadership” or “laddership.” At Ulu, we strive to: lead by example, build character by treating others well and fairly, help people grow, and improve the venture industry. We want entrepreneurs to choose to work with us because they believe we will be great partners. We don’t want entrepreneurs to work with us because unbeknownst to them we’ve taken advantage of them or merely because we’ve given them the first term sheet or the highest valuation.
With respect to products, Ulu looks at the following factors:
Learning Orientation: Great products are really hard to build. Great product designers optimize their product design to learn quickly and adapt. They look to lower the cost of learning and experimentation. Ulu looks for entrepreneurs who appreciate this challenge and are aware of their product’s shortcomings rather than trying to “sell” us on how good their product already is. Stories of a failed feature, or needing to pare a product down to something users employ frequently, are not dings, but marks of agile learning.
Enterprise IT Appreciation: Many founders do not appreciate the complexity of Enterprise IT adoption, especially due to human and organizational factors.
In a nutshell, it’s not enough for software to work.
The early adopter enterprise user must derive enough value from the product to overcome the inertia of not using it, and to champion you within the enterprise and to other prospective customers. For a pilot to be successful, you may need: single sign-on, tightly-managed integration processes, handholding of the initial customer, colocation during the pilot phase, a disciplined way of observing users as they use (or avoid) your product, etc. Entrepreneurs who acknowledge and design for these challenges score highly.
Demos make entrepreneurial vision concrete. We like seeing cool new technology in action. We love good demos. They show us how founders talk to customers. Good demos focus on how the technology solves problems that are truly important to the customer. Bad demos go through feature after feature in excruciating detail without connecting to results that matter. We highly recommend Peter Cohan’s work on making great software demos.
The Whole Product is the core product plus everything needed to create a compelling reason for customers to buy and enjoy using a technology. Said another way…
The full experience is the product.
Building a whole product is crucial for moving from selling to early adopters to the mass market. Early adopters are willing to accept significant headaches in order to be the first to adopt cool, new technology. Mass market customers, however, are not willing to accept these headaches. They want things to work and value to be proven. UIu values entrepreneurs who are sensitive to whole product issues such as the psychology of end users, the culture and context in which the solution will be deployed, and a disciplined process to observe what users do as opposed to what users say they do or will do.
(Further Reading: Ten Commandments of Product Development)
Our “litmus test” for investing is a 10x or better probability weighted multiple on invested capital. Valuation, Dilution, and Exit Multiple are direct inputs to this analysis.
Valuation is the most important investment term for us at the seed stage. Or, in the case of a SAFE or note, the cap on conversion is roughly equivalent to a valuation. An uncapped note almost always disqualifies a startup for us because it makes a risk/return analysis extremely difficult to perform. More importantly, the lack of a cap misaligns interests. In such cases, Ulu is “better off” as an investor if the round in which we convert has a low valuation. In a sense, helping you grow your business, connect to great follow-on investors, close that key hire, all work against our financial interests when a note is uncapped. It’s difficult enough to build a successful startup without such additional friction in the relationship. It’s sand in the salad.
A Business Model is your working theory for how your company will make money. We evaluate business models looking at, among other factors, long term unit economics. When your business has matured and the full value of your “special sauce” is recognized in the market, how much do you make on each customer or each unit sold? A business model with high margins, is more forgiving, potentially allowing an entrepreneur to grow his or her business with fewer dollars raised or to make mistakes and have the financial wherewithal to recover. Lower margin business models are more likely to die when faced with high costs of customer acquisition, competitive pressures or difficult economic conditions.
Dilution is the reduction in the ownership percentage of existing shareholders from subsequent equity issuances. Even the most successful startups experience significant dilution as they hire employees and raise additional capital.
Capital efficient businesses tend to experience lower amounts of dilution and lower chances of running out of money. This is a tendency, not a rule as growth strategy and competitive forces may lead to a desire to raise more capital, more quickly. Two of our most highly valued investments, SoFi and Palantir, have each raised well over $1 billion in funding.
Exit Possibilities: Ulu’s model is to invest in startups with industry transformation potential. Historically, success has led these kinds of companies to file for an initial public offering. Hence, Ulu benchmarks exit multiples based on analogous publicly traded companies. Strong M&A possibilities are a bonus, but they are a smaller driver of our exit assessment.
Why are you going to win in this market? What are you uniquely bringing to the market that will enable you to outcompete established incumbents and future up-and-comers? A market share assessment would be the ultimate goal. However, this is complicated. At this early step in our process, Ulu often uses Super Powers as a proxy.
Competitive Advantage: In the enterprise, every problem creating true “pain”, has competing solutions. Incumbent solutions, even if it is only pencil and paper, have super powers of their own. In this case, ease of use. How are you going to compete and win long-term? For most startups, technology is not a sustainable differentiator. Technology moves fast or can be replicated. ‘Hot’ markets attract talent and excessive capital. Too much competition diminishes the market opportunity for all. Ulu prefers startups in overlooked, big markets solving painful problems with competitors whose primary super power is customer inertia.
Network Effects: are the long-term advantages Ulu finds most credible. According to NFX,
Networks are interconnected systems of things or people. Network effects are mechanisms where every new connection makes a product or service more valuable to every other connection. Examples include physical networks (landline phones), marketplaces (eBay), personal networks (Facebook), platforms (IOS, Android), data (Yelp!), and many others.
(Further reading: The Network Effects Bible)
You don’t need to score highly on all factors to move to the next step in Ulu’s process. The number of startups that pass this stage is a function of all demands on the investing team and the comparison of your results wiith those of other startups being evaluated at a given moment. Ultimately, the currency Ulu is trading in is limited time.
For those who make it past our initial filters, the next step in Ulu’s process is a market mapping session. You can read about and see an overview of the process on the Ulu website. https://www.uluventures.com/philosophy/market-mapping/