How do investors evaluate startup pitches?

An angel investor’s task is to predict the potential of a company based on early indications and very little else. There is no infallible process for doing this. This is the risk investors face; and the fear they must overcome to invest. Only then can they give themselves a shot at the returns available from a shrewd investment.

Your task as an entrepreneur seeking finance is to mitigate and alleviate that sense of fear and so lower each investor’s risk threshold. The two basic ways of doing this are:

1 – Demonstrate that the perceived risks are smaller or more easily overcome that they initially appear.

2 – Set out a credible vision for the success of the business such that the returns outweigh the risk.

This, you might argue, is easier said than done. And you’d be right.

In my experience, entrepreneurs who understand how investors assess deals, find it easiest to raise money. It’s part of the reason why people who’ve raised money before find it easier to do it again.

SO THIS BEGS THE QUESTION, HOW DO INVESTORS EVALUATE STARTUP DEALS?

As I touch on above, this is a hard thing to get right for investors – a company may tick all the boxes, but still fail down the line. But this is often a matter of luck and down to factors beyond the investors’ control.

In their evaluation steps, investors can take measures to ensure that the companies they do go into have the best chances of success.

So here’s a simple evaluation framework that we recommend to investors on Angel Investment Network. We base this on our own experience from 12 years’ hand-selecting startups for our brokerage division. Companies we’ve worked on include: SuperAwesome, SimbaSleep, Novastone, What3Words, Opun and Cornerstone.

Two of these were just named in the Independent’s Top 10 startups 2017.

A SIMPLE EVALUATION FRAMEWORK:

1. TEAM

A team for inestors

We interviewed Jos Evans who has made a number of successful investments through us. Jos gave the following advice:

“Everything comes down to the quality of the founders. If the people are excellent they will succeed regardless of whether the initial business idea works. Meet as many people as possible and cross check your network for people who might know the founders of a company you are considering investing in.”

This is sound advice from someone who is making a career from angel investing.

It is the people behind a company led by the founders and validated by their advisory board that will optimise its chances of success. If the founders are relentlessly resourceful they will find the iteration that makes the company a winner.

In their due diligence, investors spend a long time researching the founders’ backgrounds. They also often try to spend time with them on the phone and, if possible, in person. The qualities that come across go a long way to giving investors confidence and lowering their risk threshold.

Similarly, the strength of the company’s advisory board can be a very strong index of potential:

1 – It reflects well on the founders if they have managed to persuade impressive people to back them.

2 – The fact that impressive advisers have backed the idea lends credibility and validation to it.

3 – The financial and social clout of high- profile board members means that the idea will struggle to fail. propelled on by a strong support network, companies tend to find a way.

2. MARKET

Which is the more significant indicator of success – the team or the idea/market? This is an ongoing debate between investors.

Renowned US investor, Ron Conway, believes, like Jos, that the team are the foundation. The idea is liable to change, but the team’s motivation, talent and competence will remain to drive the project to success.

Other investors argue that great founders in a bad market are far less likely to succeed than bad founders in a great market.

But to polarise these two points of view misses the point a bit. Good founders will find good markets – otherwise they are not really good founders.

So, in your pitching docs you need to make sure you give clear details on the market opportunity. Are you pitching a scalable opportunity in a market of sufficient size and growth trajectory? And are you doing it at the right time?

Here is the advice we give to investors when they evaluate the market section of a pitch:

“…you want to research the market to ensure the opportunity is or will be as large as the founders claim. If your findings confirm theirs then you can feel comfortable that a) there is a significant market and b) the founders know what they’re on about!”

Remember, your pitch/business is as representative of you as you are of it. In trying to sell your pitch to investors you need to sell yourself and vice versa.

3. TRACTION

Investors want a startup investment to have as much real world proof of concept as possible.

What better way to give confidence? If you can exhibit positive feedback, high user retention, growing revenues, etc at an early stage, it proves the venture (as far as possible!).

The more traction a company has, the more ‘proven’ it appears and thus the less likely it seems that it will fail. When we remember that persuading investors is about lowering their risk threshold, it’s clear how important traction points are. Traction points instil confidence in the vision and its execution.

They are as close to evidence as an early-stage startup is likely to get.

An obvious concern for early-stage companies is that they feel they may lack traction. They are especially likely to feel this way if they are not generating revenue.

So what constitutes traction?

Traction is anything that validates your business. This will depend on the business: sometimes it will be revenue; sometimes it will be downloads or subscribers; sometimes it will be page views or awards.

In their efforts to provide traction points for their startup, entrepreneurs often make the mistake of relying on ‘vanity metrics’. For instance, an app may have had 100,000 downloads in its first month. But if 97% of those users never use the app again, the initial metric flatters to deceive. Most investors will work this out very quickly.

So the traction points you choose must actually prove the value of your business or they will undermine your pitch.

The best way to think about this, I have found, is to work out what your North Star Metric is. North Star Metric is a term coined by Growth Hackers to describe the one authentic value which shows that the business is doing what it set out to do.

4. IDEA

The points above help qualify the idea itself as valid. But we should not underestimate the effect of gut feeling when it comes to an investor’s initial assessment of an idea.

The timeless human fondness for the ego means that an initial gut feeling can have a powerful effect on the ultimate evaluation of the investor.

If an investor feels that an idea is good, they want to be proved right.idea for investors

So when an investor first reads about an idea, if they think it is a real solution to a real problem in a real market, they are likely to pursue the opportunity. They want to vindicate their instinct.

This is a classic example of cognitive bias. This is the term used in psychology to describe when it is hard to undo your initial judgment because your brain will keep finding evidence to support that judgement.

It’s why the hotel industry focuses so hard on the initial impression it creates in the lobby. If the atmosphere and décor feel high-end and luxurious and you are handed a complimentary glass of champagne, your whole stay will be filtered through the lens of this initial assessment. If the lobby is grubby, your bias will lean in the opposite direction.

This can be capitalised on by entrepreneurs. When you set out what your business actually does, do so in such a way that plays up to this bias. Make a clear and powerful first impression.

How?

The visual impression of the design of your pitch deck is very important. But so is the clear articulation of your value proposition.

We tell investors to assess whether the business is offering a real solution to a real problem. So, entrepreneurs should set out their idea using this ‘Problem/Solution framework’.

Here’s a quick example of what I could write for Angel Investment Network:

Problem: The startup industry is huge, but access to finance and investors remains difficult for entrepreneurs…

Solution: Angel Investment Network’s platform connects entrepreneurs with 130,000+ angel investors from around the world so that they can realise their potential and grow a lucrative and successful company….

The principal value of the service comes across clearly and concisely.

5. WHAT DO OTHER INVESTORS SAY?

We have seen how the advisory board can be considered a metric of sorts for future success. It follows from this that other investors can be invaluable sources of insight.

Many investors say it takes away a lot of the stress if you can share the experience. That’s why syndicates, both official ones and groups of like-minded friends, are so popular. Others may have spotted some key index of potential (success or failure) that one investor on their own may have missed.

If you already have investors on board, it is, therefore, a good idea to ask them if you can share their contact details with prospective investors.

This transparency is likely to give investors confidence in you. And allow them to allay any fears they may have by talking to people who have already invested. One caveat to this is that a prospective investor may point out a flaw that the existing investor may have overlooked!

Summary

There are many factors that any individual investor may take into account when they evaluate an opportunity. This article has aimed to cover the most general and universally useful for entrepreneurs.

But you should expect each new conversation to be different. Every prospective investor wants to see whether you are a good fit for their personal investment agenda.

On that note, it is worth saying that you should never take it personally when someone decides not to invest. It is a) a huge waste of emotional energy and b) pointless. There are so many reasons why someone may choose not to invest. One of our entrepreneurs once became despondent because a good investor had withdrawn. Little did they know it was because of a divorce!

Rejection is also a good opportunity to get candid and constructive feedback from people with real expertise – sometimes what hurts the most is the most useful in the long run.

I originally wrote this article for Toucan.co blog. It was well received so I thought I would share it again.

Proposal Tip of the Week

What’s the point of a proposal? Why use sites like Angel Investment Network? Why not just send your full business plan to people you want to invest?

Well, for a start, not everyone has the contact details of a large number of investors just sat in their inbox. Networking/Connection sites like Angel Investment Network hold the key to advertising your latest business venture to thousands of prospective investors so that you can find the right ones to suit the nature of the project. That sounds a little sales-y, I know, but it’s important to understand in order to realise the significance of the short proposal instead of the full-blown business plan.

When you’re marketing an idea to thousands of people, not just in the fundraising community but anywhere, you cannot simply take it for granted that people will actually take time to consider your idea; in any marketplace thousands upon thousands of ideas are competing to grab the attention of the onlookers. Precedence is not always, and certainly not necessarily, defined by merit, but rather by the ability to capture attention.

Don’t think ‘I know my idea is brilliant, so why wouldn’t investors read my business plan? They’d be stupid not to…’ That attitude will help you raise the square root of nothing. Think instead ‘How can I make it so that investors literally cannot wait to get their greedy paws on my business plan and start properly digesting my idea?’

Here’s where your short proposal comes in. It is meant to be pithy and concise. Something that can be easily understood and result in them wanting to know more. It is the first rung on the ladder towards them investing; and that can often be the hardest part – getting them to step onto the ladder. Once they’re on, of course some may fall off on the way to the top, but at least you’re beginning to win them over and it becomes progressively harder for them to get off.

As such you should consider your proposal as a ‘hook’, to use Nir Eyal’s term, or in internet-speak a CTA (call-to-action). In your proposal make them love your idea enough to take the next step. Tell them the best bits. Don’t swamp them in superfluous detail.

Proposal Tip of the Week

It’s funny what working near a beach for 3 weeks will do to one’s ability to keep their blog updated! But I’m back in the office now, back to the grindstone so your weekly dose of pitching/proposal advice is back up and running.

The previous 4 tips have talked in general terms about the ideal structure for your proposal: Tip #1 advised you to put your achievements first, Tip #2 encouraged you to then articulate the problem you solve, Tip #3 how you solve that problem and Tip #4 told you to make it clear how big the market opportunity is.

This week I wanted to talk about tone. How should your pitch come across? Funny? Serious? Detailed? Light?

When I arrived in the office this morning one of my colleagues was bragging about how he had re-written someone’s proposal for them after they had got no interest from investors after 90 days on Angel Investment Network. Now the business wasn’t bad at all, but it wasn’t an Uber or Facebook by any stretch of the imagination. The reason the guy had done so poorly was that the way he had written his proposal was about as exciting as watching paint dry in prison.

My colleague made no drastic changes – the fact of the business and its products (innovative power tools) were beyond his control. And yet his changes resulted in 82 investors contacting the entrepreneur. 82. When previously he’d got zero.

What did he change? He injected some life, some enthusiasm, some excitement into the proposal. The subject matter remained the same, but he gave the proposal a buzz. He infused it with a sense of success just around the corner; and that’s what intrigued the investors.

So give yourself a fighting chance and make sure you strike the right tone…

Success Story: Reward Gateway acquires Yomp

Yomp • Engaging People • Rewarding Wellness from Yomp on Vimeo.

Yesterday Techcrunch posted an article announcing that Reward Gateway had acquired gamified health startup Yomp for an undisclosed figure. Techcrunch mention the £200k seed round that Yomp filled last year, but neglect to mention that £150k of that came through Angel Investment Network (the whole SEIS allowance) !

But that’s of little importance. Our investors are over the moon at such a rapid ROI. As you would be. The figure hasn’t been disclosed yet, but our £150k went in at a valuation of £1 million; and we’d expect someone of the calibre of Reward Gateway to be able to acquire for £3-5million. By that reckoning, our investors are getting a 3-5x multiple return in just over a year.

Fundraising Event Report: Last year’s successes encourage this year’s investors

Last Tuesday we held our first fundraising event of the year at the Olswang offices in Holborn. Treated to a complimentary feast of canapés and drinks on the top floor, investors enjoyed pitches from 7 of the hottest UK startups.

James Badgett, Founder of Angel Investment Network, opened the proceedings by calling to mind some of the notable successes from companies who pitched through us in 2015 as well as the general growth of our site.

Here’s an overview of what he said:

Our Website in 2015 – The Numbers
– Reached 450,000 registered entrepreneurs
– Reached 100,000 registered investors
– Averaged 1380 new proposal submitted each week by entrepreneurs
– Over 2 million proposal views
– 75,000+ connections made between investors and entrepreneurs looking for funding

Companies that Pitched in 2015 – Where are they now?

SuperAwesome, a child-safe marketing platform, completed a funding round with us at a valuation of $3million and subsequently completed a $7million raise at a valuation of $25million. They are now raising at a valuation of $70-100million. That’s a potential return for our investors of 20-30 times in a little over a year!

What3Words, an extraordinary piece of software that’s changing the world’s address system and for whom we filled the seed round, recently received $2million from Intel Capital. They also won the Innovation Grand Prix at the Cannes Lions International Festival of Creativity.

Acquisitions:
As covered in a previous blog post, Uncover were acquired by Velocity resulting in strong, quick returns for our investors.

Draper & Dash, a high-end business intelligence company with an absurdly impressive track record, and PASSNFLY, an innovative airport check-in application, are both under offers for acquisition.

After this introduction, it was fascinating to observe the investors sit forward in their seats and treat the latest cohort of entrepreneurs pitching to their undivided attention!

The future is certainly looking rosy for both investors and entrepreneurs…

The Biggest Reason Startups Fail

Ask a sample group of people why startups fail, and, assuming they have a vague understanding of the modern world,  they’ll give you a host of different reasons. Misfiring team. Poor product. No market. No business model. Delusional founder etc. And undoubtedly, they are all true depending on the circumstances in which the particular startup failed.

But there is a root problem to many of these problems. And it’s a simple one: a lack of tracked data, or perhaps simply a wilful ignorance of it. Data is the only means of empirically measuring the performance of your startup and building good practices upon proven foundations. In other words, tracked data gives you actionable insights where you would otherwise be guessing. Build upon what you already know to be true and your chances of avoiding ultimate failure will be much greater.

What this means is that failing on a low key level can be invaluable for the knowledge it provides; and as such, a failure can be considered a success if you properly understand and learn from the data you receive. Knowing what not to do can thus be as important as knowing what to do throughout the early stages of your venture.

This is the important point about success and failure. Micro-failures are useful stepping stones to ultimate success provided the data is tracked and learnt from after each attempt. As Elon Musk, CEO of SpaceX and Tesla Motors, puts it; “If things are not failing, you are not innovating enough.”

Here’s the article that got me thinking: Why do Startups Fail?