I was meeting with an experienced serial entrepreneur who had the right mix of education and successful exit credentials…. two very important hurdles to cross for founders seeking investors.
His Idea was big. Possibly a home run and, more likely, a spectacular failure. He was in a very early stage, with some patents applied for, minimal non-operative code completed, no team, a list of 20 or so all-star advisors (of which none had invested a dime), and no investors or investment to date.
So the conversation went something like this:
Me, “I don’t think this is an angel deal because of the capital it’s going to require to execute and it certainly isn’t a DC angel deal. This isn’t the kind of deal I do. In fact I can’t think of anyone in DC who would do a deal like this with the possible of exception of New Enterprise Associates (NEA). You might do better in Silicon Valley with VCs or super angels.”
He, “My advisors tell me that I should start with a small angel round 1st and then go for VC money. So I want you to invest because I need Angels to invest.”
Me, “Well your needs and my needs aren’t aligned. Why haven’t your advisors, (some of them wealthy cashed out entrepreneurs and VCs) Invested?
He, (the sound of tumbleweeds and crickets)
Me, “Are we done here?”
He, “What would I have to do to be better positioned for an angel investment?”
Me, “Pass some hurdles. Build a prototype. Have proof your hypotheses’ on customer acquisition cost and life time value of a customer have some relationship with reality . Show me that your willing to invest your cash alongside mine.”
He, “So maybe we can revisit when I cross some hurdles.”
Me, “Maybe.”
Making an investment entails evaluating risk and reward. An entrepreneur’s job is to show proof points that the rewards are huge while supplying evidence that the risk is low. Rewards are kind of binary, how big is the addressable market. Risk is defined as crossing a series of hurdles. The more hurdles you cross, the less risk.
The Hurdles
- Technology Risk – Can you build this product? In many cases, the product isn’t rocket science. There is proof elsewhere that the technical hurdles are not daunting. In cases where the technology is truly breakthrough, the technology must be proven.
- Customer Acquisition Risk – Can you prove how much it costs to acquire a customer? Sometimes, a startup must build a prototype, not to limit technology risk but to prove that if they build it, it will be bought. Twitter is an example of technology that wasn’t risky. Yet a working platform proved that people loved it. The Segway overcame enormous technology risks only to prove that no one needed or wanted an $8K two-wheeled urban transportation vehicle with a top speed of 12 MPH. What is the message of the Segway product roll-out? Get off your ass and ride a bike.
- Revenue Model Risk – There’s a difference between users and customers. Will they pay and what is the lifetime value of a customer?
- Company History Risk – If you just started with no operating history, that’s a risk. If you started ten years ago and you haven’t grown, that’s a risk. Having some history, some operating track record of growth, overcoming obstacles, and proof of ability to execute limits risk.
- Love or Lust Risk – Sometimes I see something I think I love, and I find out too late it is only lust. That’s why I like to ensure there are others whose judgment I trust to invest alongside me. Get investors to work together. There is safety to us cattle in herds.
- Execution Risk – Does this team have a plan? Can this team execute the plan? Do they have the right people in the right seats (especially important seats, CEO, Subject Matter Expert (in tech that’s a CTO), Sales). Do they work well together, do they have a history. Did they go to the right schools (look I didn’t go to Harvard or MIT, I barely got through Univ of MD so I’m not saying you’re worthless if you don’t have a college degree or haven’t gone to an Ivy as well as I don’t want to be so presumptuous to imply that I’m not worthless). It is just that getting into a good school and graduating from a good school shows that you have drive, perseverance, and intelligence. It’s a de-risker). Have they done it before or is this their first rodeo?
Oh and one negative hurdle? A list of stellar advisers does not necessarily de-risk a deal. Advisers who barely risk their time and name only are red flags. A list of non-investing advisors is a red flag. A company that’s given 5% or more of their equity to a non-investing, non-employee adviser…. just added CEO judgment risk in my book.
When is a company ready to raise money? When it needs money people will fund it. Okay wise-ass, what will it take for people to fund it? When an investor is willing to bet on the company based on its risk-reward scenario. There are multiple factors that affect the calculation. No company is the same, and no investor is the same. Each situation is different.
Just know that after establishing the value of the reward…. de-risking the scenario by successfully running over as many hurdles as possible will help.
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