How do investors evaluate your startup company? Let me take some of the mystery out of the process and tell you one approach. It’s not the only approach and different investors will put different weighting on different parts of your company. The goal of the post is to help you be self-aware and ask your yourself if now is the right time to pitch your idea to investors for funding. This is a different process then pitching your idea for validation.
Please remember that your personal/business need for investment is not at all correlated to your ability to actually raise money. Your business may require money. But the stage and traction of the business will be what is required to actually raise the money.
The following are listed in no particular order – think of this as a set of criteria as a whole. First the list, then the breakdown, with examples of the reason for the scores. This scoring applies to “Venture Scale” companies, not all companies. Venture Scale is where an institutional investor (investing other people’s money) can get a 10X-100X return on their investment. Other investors may look for smaller returns, but in general VC’s are looking for the potential for outsized returns.
All scores are ranked on a 1-4 basis. I know my statistics friends will hate this method because there isn’t an odd number and the range is so small. However, a Net Promoter Version of 1-10 applies a level of precision that isn’t available and 1-4 eliminates a human nature problem. There is no “3” in the equivalent 1-5 scale, the reason is a middle score doesn’t actually help the company. It just kicks the can down the road and makes the team feel better than they should. In Seattle, it’s called Seattle “Nice”, people don’t want to give you honest feedback. It’s hard to give and many founders don’t it well. The Founder Institute did a 1-5 Scale at but asked mentors not to use the three.
This is by no means Quantitate Venture Capital. There are areas that can be measured for investment. However, this process is simply assigning numbers to a predominantly qualitative criteria. Even so, it’s a critical qualitative measure.
- The evaluator hates (strongly dislikes) your idea – hate is such a strong word… so think of it as a “1”
- We don’t like it – not as negative as a 1, but still… you may have missed something in your pitch or a major milestone. Think about attending a Pitch Clinic or “6 Month Startup – Ideation to Revenue” and get some coaching.
- We like it! That’s not a 4, we don’t love it, but it’s a good place to start!
- We Love it!
Event Name: _________________________
Event Location: _________________________
Event Date: _________________________
Domain Experts Diversity Serially successful Founders From great companies Functionally competent (hacker, hustler, designer/marketer)
Big “category” Idea Early/Late continuum Technically Achievable “Pain pill or vitamin” In our investment thesis
Customer first focus Clear Value Prop Design/Ease of use Clear launch and scale offering
How big is the market – TAM/SOM Unmet customer need How many incumbents Nascent Go-to-market system
Barriers to Entry Differentiation Well funded competitors in Crunchbase
High transactional value Clear Profit Model Capital Efficient -anything about previous financing/cap table? Scalable No “Bad” things on Cap Table
Customer adoption Customer Engagement Early Revenue Know the Unit Economics
Emerging innovation “Meta” factors are favorable Established demand
IP Required IP in process
Notes on Scoring Examples
The examples below are just that, examples. Each investor is going to look at your startup company through their own lens. This is designed so you can both do a self-evaluation and understand how you will likely be judged. Scoring high does not mean they will invest in your company. Investors tend to invest in markets they know. For example, if your business is a B2C game and the investor does enterprise software. I’ve also found that people seldom invest in markets that are new to them, in one case I was running a company in China and investors were either intersted in the country or the business but if they didn’t know China they wouldn’t invest.
- Solo Founder or Part-time founder. Investors don’t like solo founders. It has nothing to do with how amazing you are personally, mind you. We just know that it takes more than one person to build a company. Solo founders tend to auger in on an idea vs feedback from the team when it’s time to make a change.
- Incomplete team or not balanced (lacking a tech or marketing role). Offshore development with no plan to bring on as employees
- A balanced team with complementary skill sets, market experience, startup experience. Some track record together.
- Experienced startup team with industry experience,
Bonus points – well balanced in gender, diverse. The data shows that diverse teams produce better results. Also, an early stage investor is going to be with you for 7-10 years so likability matters.
Negative points – married co-founders? Sorry, though I’m a fan, investors view it as a compounding risk. A relationship ending poorly is the fear, real or not. Just know what you’re in for, you don’t have to change, but that doesn’t’ mean the investor will view you differently.
- You’re doing the next “Groupon” or insert any other crowded market of competitors (Food Delivery, Home Repair, Travel Rankings). You’re solving a problem that isn’t really a problem. I love the internet connected belt idea, not.
- You’re a feature of someone else’s product or a tool. It doesn’t mean you are a bad tool, but it likely won’t be Venture Scale. Think plugins for WordPress or Shopify vs Shopify itself.
- Good market, though not huge, could change a market but not the world. Think about a product that has a limited geography, e.g. only Brasil and Portuguese.
- Disruptive ideas are very unique. When you find an idea that really could be a $1B idea it’s special. Big market with the right timing solving a genuinely big problem.
Bonus points – unique ideas are amazing and every idea is crazy right before it works. Excitement is valuable as people like to rally around a great idea.
Negative points – Your Non-Disclosure Agreement (NDA), no real investor is going to sign an NDA unless you have a cure for cancer or a real scientific discovery. Don’t worry about someone stealing your idea, worry that you’ll waste three years of your life not discovering that your idea had a fatal flaw that other people could have shown you.
- A concept on a napkin – the concept might be interesting it’s just that, only a concept. No working prototype – there are a number of ways you can get a prototype showing for cheap. Here’s a link to a Series of posts for how to build an MVP starting with a specification.
- Working prototype, but ugly. This is where the developer is the designer. Think about a home that has pipes and plumbing showing in the walls because the plumbing design (code) was so awesome it didn’t’ need an interior designer. Functional but ugly seldom gets a second chance. Minimum Viable Product (MVP) show’s what’s possible. At very least a PowerPoint demo including design.
- All of the pieces are they and your gaining valuable customer feedback from people. Basic functionality should be included, not just a WordPress site.
- Function and design, it works and it’s beautiful. MVP moves to KAP, Kick-Ass Product. You’ll know it’s a KAP if people go to download it after you do your demo.
Bonus Points – you’ve taken customer feedback and built an email list of prospects that give you feedback and have a regular cadence of shipping (two weeks). That email list should be growing every week as you get feedback.
Negative Points – live demo doesn’t work. It’s a “platform”, platforms happen when you have “scale”, not at your launch. Though that may be your aspiration you don’t have that today and it usually means you don’t know what customer you are going to serve.
The Market and Customer are two sides of the same coin but warrant some explanation. TAM/SAM/SOM/LAM are terms that address the “macro” market as a whole. Customer reflects the “micro” of the market
- Small Markets suck. Selling to customers that don’t have money means you are doing a non-profit. Sorry to be the bearer of bad news here, but an app for the homeless needs to be funded by grants and donations not by investors that expect a return on investment. Customer’s that don’t have money to spend on your product is also a problem
- You have a great launch feature, but the market and customer need a complete solution in order to use it. This means you’re going to need to raise more capital before getting
- It’s a good market, but no longer growing.
- You know both your market (large and growing) and your customer (persona). Nascent or new markets are exceptional, e.g. Uber or AirBnB.
Bonus Points – if you have experience in this industry or unique knowledge or a complex market.
Negative Points – you calculate your TAM wrong because you want it to be HUGE! Hypothetically you make headrests for front passenger seats for trucks. In this example, you’d say the market TAM was the entire automotive market vs the subset of seats, subset of passenger seats and real TAM of headrests for passenger seats and further to the automotive subcategory or trucks. It’s a ridiculous example, but you’d be surprised how often founder routinely overblow their TAM! Be realistic about the actual TAM.
- No Competition – this likely means there is no market. The positive version is that you are too early to market and it will take a long time for the market to catch up to your visionary status.
- Busy market with a lot of competition that has already been funded. This equals late to market. You know you are late to market if there are already a number of companies that have raised >$10M in the market. Even if your product is better, your ability to raise cash will be very, very limited.
- A little late to market but against lethargic competitors in this category. Entrenched incumbents that haven’t yet been disrupted
- Early, but not too early is a great place to be. Keep in mind it rarely happens.
Bonus Points – You know the gaps in the market that current competitors are not offering. These gaps have been discovered because of your knowledge of the market and customer interviews (50-100)
Negative Points – being cavalier about the competition. One challenge I see often is people waiving off the competition vs taking the Andy Grove approach
I admit I’m super Geeky about Revenue Models – someone needs to be. There are a lot of products that can be made with technology but shouldn’t be made because the founder hasn’t thought about the cost of selling the product and how to make a reasonable to exceptional profit. Knowing how you are going to make money is critical to the investor. From there point of view, it’s easy to get a check into a company, but hard to get a checkout. If you can’t explain the economics of how you’re going to make money don’t expect a check.
- You don’t know how you’re going to make money yet and you’ve only thought about the cost of building the product, not the cost of selling the product and a reasonable margin.
- Low transaction value markets – if you only make >10% margins or your margins are in Basis Points (BPS) there isn’t a lot of room for error on execution. You’ve created value for your product but you haven’t captured payment for the value created. Services businesses also fall into low rankings in this category, they don’t scale without adding additional staff. If you productize a service it will help, but they don’t scale like other models.
- High transaction or high margin – if you can start with at least one of these you show that you can capture value for the product.
- Recurring revenue subscriptions and combination business models (e.g. transaction fee + subscription) win the day for best score. Monthly recurring revenue is the truest gauge of churn. Annual Contract Value (ACV) is a good measure, but if you have a large price point you’ll likely have higher churn as you develop the product. NOTE: you don’t have to accomplish all of these things yet, you just need to know where you are going and have some early traction.
Revenue is the obvious starting point here but it’s not the only measure. Depending on the customer profile (think enterprise) you may need to be a whole solution before you can charge the customer. Your launch feature may be popular and become an “on-ramp” product that acquires customers for future revenue. Time on site/app may also be a measure of success, especially in the B2C category.
- No users – seems obvious but if no one is using it you have a problem. You may need money to fix it, but you’re not likely to get it from an investor.
- No payment from users – again, not the only measure
- Proof of Concept (POC) or Letters of Intent (LOIs), as well as early revenue, will get a score on the board. It shows a level of commitment from customers.
- Strong customer usage or strong initial revenue. Some rare B2C companies can move past word of mouth and into “viral marketing” – they can also become unicorns (again rare!). But if you’ve figured out how to get strong initial customer growth or for people to pay you early you’re going to score well in this category.
Bill Gross from Idealab talks about why timing is the most important factor of success in this video. It’s the best 7 minutes of video on the internet for Startups. You don’t ultimately control timing, they are outside factors that should influence your decision to start a company. Know, however, that your belief in why it’s the right timing may not sway your investors to that same belief.
- Too early or too late – you might be a visionary, but the market may still need to catch up to your idea. The other extreme is that you’re late, see Big Ideas above.
- Unclear timing – if you’re here you and the investor may not know enough about the market to make a judgment. If you don’t have any data about the market timing your score is going to fall into the don’t like it category. Think of this timing as “headwinds” that will make it more difficult to grow
- A little early or late – in this case, the investment capital is still available and hasn’t been pulled out of the market by 2-3 large players (think $100+ valuations with >$25M raised).
- You’re still in front of what could be a new or nascent market. You can think of timing here as “tailwinds”. You may also be in the current “hot space”
There are market segments where Intellectual Property (IP) is critical. This may include Patent, Trademarks and Trade Secrets. I’m not a fan of the investor question “what’s your sustainable competitive advantage“? In most modern tech-related companies your advantage will be speed to move and knowledge of the customer (through customer development). Regardless of IP portfolio, you need to have an answer to the question of how to build a competitive moat over time.
- No barriers to entry or defense. This might be because you’re selling someone else’s product (reseller) or your
- There is already a great deal of IP created in your market. You have a unique idea and product but the margins will make it difficult to build a defensive position or moat around your business.
- You have a path to defensibility. Building IP requires legal budget and time. People with patents tend to overvalue them. People without them tend to “waive their hands” at the value. They both have a place depending on the industry or vertical.
- You have speed, IP, and knowledge of the customer. You also have the budget to defend your IP.
We know you’re looking for capital, now the question is how much and what are the “use of proceeds” – what you’ll do with the capital. It’s important to connect these two items into one narrative. The founder usually knows why they are asking for $500k, but in the ask, it genrally comes across as “we need $500k to get us through the next 12 months.” What the investors hear is, “we’d like to get paid for 12 months.” The real answer is a “we have X, Y and Z milestones lined up over the next 12 months, $500k will allow us to hit those milestones with the necessary team.
If you’re looking for referrals to customers, give the customer profile and what you want. “We’d like introductions to Enterprise IT Managers that are looking for cyber security” don’t make the process dependent on them remembering your ask.
We know you have an ASK, tell us what it is!
Venture Capital firms tend to “over-index” on trends. Right now the trend is Machine Learning (ML) and Artificial Intelligence (AI). Smart capital will lead in that market based on an investment thesis. Others will follow. Then the category will move toward being overfunded. You see this with the use of “buzz word bingo” when startups through terms into their pitch because those are the categories that are getting funded.
Score yourself, your team and progress against this Rubric. It will help you know where you need to improve your progress before meeting with Angels or VCs.