Asking these 5 evaluation questions could help you make smarter investment decisions.
One of the most important relationships you’ll cultivate as an angel investor is the one with the prospective company’s management team. While there’s no way to predict a company’s future success, looking at key traits in the management team can serve as a significant indicator as to who has the endurance to take their company from the early stages to exit. David Pakman, a partner at Venrock, says: “We spend the most amount of time thinking about the founders and the early team before investing.” Like other VCs, David recognizes that the driving force behind innovation is great entrepreneurial leadership.
It makes sense. After all, startups don’t sell themselves. At the end of the day, it’s the team that is going to make presentations and shake hands with strategic partners. Still, many investors get too attached to the numbers side of things and fail to look at the broader picture when making investment decisions.
So, what should you ask while performing evaluation of the people who might be putting your investment dollars to use?
- “Why did you start this company?”
To get to the heart of a startup, you have to know why it exists in the first place. What problem are the founders trying to solve? Why is this problem important to them? How well do they understand the problem and market they are addressing? While the answer to these questions doesn’t have to be deeply personal, you want someone who is passionate about the cause with a firm understanding of the business opportunity. If you’re not convinced in ten minutes that this is something the founders are devoted to, you may want to consider other investment opportunities.
- “How big is this problem?”
Once you’ve established passion within the founding team, you have to look outward. Is this problem big enough to make a real impact on the market. Before the advent of the personal computer, human input in manufacturing was a time-consuming, labor-intensive task. Once we gained the means to simplify such tasks, the world changed overnight.
While not every product can have the impact of the personal computer, there are a few core ideas to keep in mind. Another way of looking at it is: What is the total addressable market and how has it been validated? In the case of the PC, the addressable market is the vast majority of the population, which will likely not be true for the company you are considering. However, if the startup cannot provide proof that their product will be a significant enough change to the status flow, they probably lack preparation in other areas as well.
- “Why are you the team that can make this happen?”
Probing into the experience of the founding team is a huge factor in predicting the company’s overall success. Looking into the team’s past–including their previous success or failures–can reveal their various strengths and weaknesses this time around. At the end of the day, even if a team lacks experience, if they have demonstrated an ability to surpass hurdles and develop their solution, the probability of success is much higher. VC investor Hambleton Lord says, “From the initial meeting with the company, during the due diligence process, and finally while negotiating the deal, I want to make sure the CEO is being honest, straight-forward and genuine.”
- “What are the key technology risks; market risks?”
I identifying potential risks–especially in these areas–will give you a realistic expectation for success right from the get-go. What you need to be aware of is exactly where and why this issues arise. Is the material being used to build this new product notoriously temperamental or hard to find? Is the market already trodden with like-minded innovation?
These questions can be answered not only by management, but also by independent experts. In fact, the more serious you become about making an investment, the more you’ll likely want to enlist the help of an independent expert for evaluation of the technology. Someone who knows the industry well will be able to point out potential red flags and save you hassle later.
- “What market traction do you have? Have prospects demonstrated intent-to-buy?”
Asking this question is a great follow-up to your previous insights into the market, as proof of intent-to-buy (or lack thereof) will likely reflect the previous description of the market. With early-stage companies, demonstrating the market’s intent-to-buy is not always feasible, but even checking-in to see if the founders have this goal in their sights will give you an idea of their roadmap for the company and go-to-market strategy. Do they understand the true value driver of their innovation?
At the end of the day, you will spend a great deal of time asking the management team questions before you actually get around to signing a check. As you enter into an agreement with a company, and especially one in which you may not have personal expertise, limiting the gray areas of understanding is crucial. Ultimately, the first five questions you ask are only the starting point of what will hopefully be a continuous dialogue between you and the management team. The more you speak with them as the deal progresses, the better informed you will be about where your money is going and how it’s making an impact.