What Separates the 2% of Startups My Angel Groups Invest in From the 98% We Pass?
As an early-stage investor, I meet a lot of startups. My two angel groups invest in around 2% of the companies that pitch us, a pretty typical metric.
What separates that 2% from the rest of the pack? Given how much time founders spend on pitch decks, you’d be forgiven for thinking it all about the pitch.
But I’ve seen plenty of startups get funded with a rough pitch, and conversely, many slick pitches get turned away. In fact, I’m ready to make a shocking statement: the quality of the pitch matters little to landing investment. Sorry YC.
The reason is simple: the point of the pitch is to sell an investment. It doesn’t matter how great the pitch and how wonderful the solution. Unless the investment is attractive, the quality of the pitch doesn’t matter. So rather than wasting time endlessly revising the pitch, focus first on ensuring you’re offering a good investment.
A great investment requires the following:
1. A Viable Exit Strategy
If I buy stock in your business, how and when will I get a return? Make sure you can answer that question before asking investors for money.
With public stocks like Apple or Netflix, investors are looking for appreciation in the value of the stock. We can sell those stocks at any time and take our profits, so all that matters is will the price go up. Startup stock, though, is different.
The only way an investor makes money on private startup stock is through an acquisition or an IPO. The stock can’t be traded or sold until then.
That means it’s not enough to build a successful, growing business, or even a highly profitable one. It doesn’t matter if the valuation increases. For investors to make money, there needs to be an exit.
Sometimes, the exit is obvious and there’s little need to discuss it. But most times, especially at the early stages, we need to know the plan to monetize the investment — the exit strategy. That means outlining what kind of buyers would acquire the business and what multiples of revenues they typically pay.
We need our investments to return at least 10x what we put in, and ideally 100x. You may think that requirement is crazy, but 90% of our investments fail, so we need the one out ten that succeeds to return 10x just to break even. We need our one winner to return at least 40x to beat investing in S&P index funds or real estate. (See this article for a discussion of venture math.)
Getting to 10x — 100x returns is not going to be from dividends. It’s not going to be an acquisition by private equity since they’re cheap. It won’t be an acquisition by another startup or smallish business that can’t afford to fork over a billion dollars. It’s certainly not going to be an aquirehire or patent licensing deal.
The exit has to be a strategic acquisition from an industry giant that knows it can’t survive without adding your business to theirs. So who is the giant that will be desperate to buy the business no matter how steep the cost?
That acquisition has to come quickly, ideally within 5 years and no more than 7. The longer it takes to get to the exit, the lower the IRR. A 10x return in a year is fantastic. A 10x return in 20 years is not. Most VCs wrap up their funds 7–10 years after investment, so there’s a hard deadline to monetize the stock.
Most early-stage startups look like useful businesses, but unlikely to provide the type of 100x returns that make it a good venture investment. To get us excited, show us why your startup will get acquired quickly at a huge valuation.
2. Revenue Potential At Least $100M
When you send me a pitch deck, the first thing I look at is the revenue projections.
Yes, I understand the company is early stage and you can’t accurately predict your revenues this year, much less 5 years from now. Yes, I understand the revenue projections are wild guesses, and no startup in the history of startups has ever hit their numbers. But I look at those projections first because they are the culmination of your growth plans.
If the projections don’t show the startup reaching $100 million within 5 – 7 years, there won’t be a high-value exit, and this won’t be a good investment. There’s no need to look at anything else on the deck.
A good business does not need to reach $100M. In fact, most don’t. But a venture business, which is a moonshot, needs to grow exponentially, reach $100M in a short period of time, and get acquired for $1 billion.
If that isn’t your plan, great. I’d like to see more founders be realistic and pursue strong, profitable businesses rather than shooting for the moon and failing.
Nevertheless, if $100 million or bust isn’t your plan, your startup may be a wonderful business but venture capital isn’t the way to fund it.
3. Founding Team With Both Technical and Business Chops
In the same way that real estate is about location, location, location, most investors will tell you early-stage startups are about team, team, team. Find the right team and they’ll figure everything out. But that requires the founders possess a lot of different skills and experience:
- Deep domain expertise: understanding customer needs and industry dynamics
- Business leadership: ability to market and sell a new product. It’s not easy.
- Technical expertise: a technical product requires an expert, experienced CTO to build it.
- Startup experience: does the CEO know how to scale a business from 0 to $100M and reach an exit?
Very few teams have both technical and business expertise combined with experience building startups. Which means the startup will be a great training exercise likely to fail. If you don’t have all the bases covered, expand the team with needed skills before hitting up investors.
4. Customer validation
We’ve all heard the stories of founders who have raised millions on nothing but a brilliant vision, but that’s rarely how it works.
Until there’s actual customer validation, money put into a startup is more of a donation than an investment. Your uncle and your college roommate will invest in your vision. For the rest of us, we need to see customer traction.
Investors invest in businesses rather than ideas. We need to interview users and hear their pain points directly, quiz them on the other solutions they’ve tried and why those failed, hear that your product solves their problem, and find out how much they intend to buy.
When customer are enthused, we’re enthused. When they’re ready to buy, we’re ready to invest.
5. Attractive Valuation
It should go without saying that we’re investing to make money. That means finding the best investments. Higher valuations mean lower returns and we have a lot of options. You’re not only competing against all the other startups pitching us, but against investing in Nvidia stock or real estate or taking our families on a first-class cruise.
Most founders at the pre-seed/seed stage have unrealistic expectations. They’re raising $2M on a $20M valuation, or at least trying to, before even having a product. Sorry, pass.
Even if terms are negotiable, we need to know the founders’ expectations are reasonable before we spend time time diving into the details of the startup.
And No Show Stoppers
Lastly, there can’t be any show stoppers. If you lie about your customers or revenues, that’s the end of the conversation.
If the company is not a US-based C-corp, there’s no point in having the conversation.
If you’re offering common shares rather than preferred, or raising on an uncapped note, I don’t know who will investing, but it won’t be me. So make sure you have a deal we can actually invest in before pitching investors.
Then Get the Pitch Right
If you’ve thought through all these details, the pitch should be a snap. Rather than explaining the problem and solution in gory detail, successful pitches focus on telling the story of why investing in your startup will be the best investment we’re ever made.
The startup, SüprDüpr, has a trillion dollar opportunity transforming transportation. It looks destined to be the most successful startup ever. Does it matter if the company is killing its users? Find out in my Silicon Valley mystery novel, To Kill a Unicorn.
