People with money to invest have choices. How do you as an entrepreneur with a new idea get to be one of those choices? Initially, you may be able to rely on friends and family to put you on the top of their list, but eventually you will probably need real professional investors (Angels and VCs). You won’t win with them without understanding their alternatives, as well as their mindset.
I like the work just published by Bob Rice in “The Alternative Answer,” which does a great job of summarizing the investment universe, starting with the “conventional” stocks, bonds, and real estate, but moving on through more esoteric alternatives, including hedge funds, private equity, real assets, managed futures, and finally venture funding.
Venture investing is often mentioned as the most sexy form of wealth creation, but it’s also recognized as one of riskiest. Sure, it has great up-side potential, per early investors who made millions or billions in Facebook, LinkedIn, and PayPal, but it also sports a total failure rate of nearly 50%. Most Angels I know get their payback from helping others, not from making money.
Within the venture community, the first rule to remember is that opportunities abound these days, due to the increasing pace of technology evolution, and the scope and creativity of the global community. That means there are far more entrepreneurs looking for money than there are investors, and entrepreneur entitlement is not a realistic expectation.
Since Angel investors put money into 60 times as many companies as venture capital funds, according to Wikipedia, early-stage startups need to focus first on the key thresholds that drive these investment decisions. The same hold true for venture capital investors. Here are the top five, as outlined by Rice in his book, which match my own experience:
Management team. The single most important ingredient of success is not the idea, but having a team in place that has impeccable integrity, can iterate the product quickly, pivot the business model as necessary, and keep costs down in the process. Angel investors look for prior domain and startup experience. They bet on the jockey, not the horse.
Funding risk. Will the startup be able to get to self-sustaining mode before it runs out of cash? This requires a visible focus on the company’s revenue model, the costs to get there, and cash on hand. Angels expect at least a working prototype and a hint of market acceptance (traction) before investing. Before that, rely on friends, family, and fools.
Scalability. Is your concept worthy of a company, a product, or a feature? The target market better be a big one, like over a billion dollars, with a double-digit growth rate, large enough to absorb multiple entrants. That’s because it’s a sure bet that someone else is working on the same idea – if not, it’s probably a bad idea.
Defensibility. Angels want to fund a startup whose implementation can’t be knocked of by just anyone. But patents and other intellectual property only go so far. Additional protection is always the speed of the initial implementation, and the ability to iterate quickly. That goes back to the strength of the management team as the #1 threshold.
Exit strategy. What’s most realistic these days is an exit via sale to an existing major company for which you solve a meaningful problem. That means merger and acquisition (M&A), not initial public offering (IPO). Shooting for that sort of exit over a three to five year period is usually the best strategy. No exit strategy means no return to investors.
The hype is high right now for equity crowd funding as an alternative to Angels and VCs. Rice and I are not so sure. When legal, it may be an alternative if you only need a small amount (less than $100,000), and don’t ever plan to come back for more. No VC or Angel investors I know are interested in a bunch of angry, crammed-down small investors as co-shareholders.
Most investors like the idea of adding venture investments to “diversity their portfolio,” and create great up-side potential. They don’t like the fact that your track record and traction are unknown, there are no analysts to rate competitors, and getting money out may be a challenge. Maybe it’s time to shorten your product pitch and talk more to investors about the things they really want to know.