Recently – over the past several months – I have gotten a chance to take a journey with some of the brightest people I have had the good fortune of working with to this day. During this time, I have learned many lessons – legal, personal, professional, financial, etc. – but one that struck me as truly interesting was the focus on investment criteria, and how it shifts as the company evolves.
Your First Round
Your first round of funding – an angel, friends and family, or ‘seed’ round – is usually a smaller number (it can be less than $100,000 depending on the business). In this round, new entrepreneurs (although I am hardly a vet at this point) tend to focus on what they think matters – and that is the first mistake they make. These would be fundraisers put together business plans, forecasts, financials, summaries, etc. etc. While important, those are not what will make or break your case. What I have come to appreciate, is that at this point in the businesses development, all of your planning means almost nothing.
You haven’t started hiring yet, you haven’t started building yet, you probably haven’t even started talking to clients yet. At this point, investors are only concerned with one thing – the team, and more importantly, the CEO (and other management team members).
This makes sense if you think about it. At the genesis, your team is most likely very small, and for that reason each individual will have a tremendous amount of impact on the company, none less so than the CEO. The CEO needs to be patient, passionate and persistent (trying saying that fast three times!) – and that’s what a smart investor will be looking for.
Investing really is a form of educated gambling – the investor feels they have an edge, and puts money (the wager) on the line. In the first round, there isn’t much to go on to determine the odds of success in the business (aside from a general assessment of the idea), so the criteria for wagering comes down to the people.
After the First Round
As financings progress, the company will grow. It will hire new people, get involved in new activities, and build out different businesses. The leeway that the business was given during the first few fund raisings will start to erode. New data will rapidly accumulate, providing investors with a much more calculated guess as what the odds of success or failure are, which will determine their next wager.
As I see it, investing is a spectrum; on one side is ‘The Team’ and on the other end is ‘The Business’. As your business grows – both in age and equity – the pendulum starts to shift from the left hand side (The Team) to the right hand side (The Business).
What Does it All Mean?
Well my thoughts on this matter might be good and dandy, but what does it mean to you as a would-be-entrepreneur? It means a couple things.
Firstly, think long and hard about your founding team – these are the people that angels will base a large portion of their decision criteria on.
Secondly, you need to prove your business model – and the sooner the better. Angels and other investors will invest in an idea, but over time their investment criteria will move from the idea/team to the business – and the business needs to be functioning. That means as an entrepreneur, you need to understand that you are under time pressure – as the scorecard your investors are using to evaluate you is shifting towards the tangible every day.
The Good News
The good news is that there are people out there willing to take a risk on a great team with a great idea – because it sometimes has huge payoffs. Just be cognisant of this fact: what got you money yesterday might not get you money tomorrow.