Early stage ventures usually have limited revenues and earnings or no earnings. However, the prospects of hockey-stick growth and substantial profits in a few years make them attractive investments for angel investors or early stage VCs. While each venture seems promising during early days, very few becomes home run for investors. Especially in angel investments, the success rate on investment is very low. Traditionally 20 per cent of the investment would succeed provided portfolio is well diversified. There is no specific data point to show which investment would be home run, since substantial number of companies would fail to make it big and hence investors do follow certain criteria for evaluating investment opportunity before signing the dotted line. The investment criteria may differ from investor to investor, but the points given below would help understanding few broader points.
The team, especially founding team, is very important for any venture. There is very little to evaluate at the beginning of the venture, but a team. The factors that are considered important for investors to evaluate are:
* How well the team is prepared to execute
* What diversity they bring on table
* Relevant experience to execute
* Are they prepared to face risk and uncertainty
* How well the team is geared up to change course if needed
* Promoters’ understanding of accounting and finance
* How logical they are on their assumptions
* How well the team is focused on their concept
In early stage investments, the single most important factor is team and hence it is the most important investment criterion which investors use to grade the potential opportunity. Normally, investors look at both depth and the quality of the team and their preparedness to meet the challenges with given skill sets.
Gauging the market potential
Investors prefer to invest in a high-growth market so that they can exit their investments at higher valuation. There should be a strong market for company’s products/services for investors to get excited about the opportunity. If not, investors may choose to explore something else as the risk matrix won’t justify investment. There are few things which investors normally evaluate:
*How big is the overall market both domestic and international
*How fast a market can grow and does the company have relevant skill sets or resources to serve the growing market
*Is there any competition, if not how soon competition can catch up
*What kind of substitutes are available and can it be threat for company
*What distribution mechanics works in the market and how well the company is prepared for it
*Access to the market
If it is a tech company, then investors will certainly evaluate technology very closely and will stress on following:
*Is there any IPR
*Are you infringing anybody else IP
*The team working on the project
*How disruptive is the technology
*What pain points are being addressed
*Will big-time changes be required for adoption of technology or it can integrate seamlessly
*What stage is the product development
*Is the company ready to go to market or does it need to work on some missing links
*Whether the company is capable of completing the work at large or not
Once investors have evaluated team/market opportunity /IPR, they would like to see how the team will execute and how robust is the business plan, to get an understanding of how the venture will make money. Investors would like to understand that how team is able to create differentiation, how to protect the same and how fast they can scale.
*There should be clear differentiation in offering
*How disruptive is your strategy to offer undue advantage
*What’s the strategy to lock-in the customer to create entry barriers
*How fast you are able to scale
*How to generate more revenue without much increase in expenses
One of the most import pillars of the venture is finance and investors would like to evaluate following:
*Use of fund: How the fund will be used, like how much on development, on team, market development, working capital etc. Paying debt will be a bad idea as investors want to see money being used for business growth and not for paying debts.
*Financial Risk: Does the company run a risk of raising money too fast or will current funding last long enough, enabling the venture to start generating revenues before next round of funding or will a change in the market dynamics risk your investment etc.
*Financing term: Very important point, which may vary from investor to investor. and also based on rules and regulations in each country. This should be dealt with in the best interest of company and investors
*ROI: Again this will depend on investor to investor. However, the end game is to make money and investments should have potential to be a multi bagger
This is equally important for investors to evaluate while making investment. The entrepreneur should have some visibility on the potential exit to investors whether it is thru IPO or M&A. The option of IPO or M&A will depend on company’s growth plans and its ability to exploit the same. The above points are not exhaustive. However, it will help start-ups to prepare for fund raising. Watch this space for more.
(Anil Joshi is the President, Mumbai Angels)