When you think about the plethora of investment opportunities out there, it can be overwhelming. There are so many options that it is difficult to know which are the potential stars. The whole point of venture investing is to identify high potential startups early on and invest before they actually take off. By doing this, you assume more risk, but the potential returns can make it worthwhile.
Investors often review thousands of opportunities before selecting where to allocate their capital, so having access to a high quality deal flow is key in building a strong portfolio. Here are some good approaches to improving your deal flow:
- Network, network, network. There is a growing number of startup-focused networking opportunities emerging all over the country. Use these as an opportunity to get your name out there as an investor and meet lots of potential startups along the way.
- Join an angel network. If you’re not interested in building your own deal flow or you just don’t have the time, join an angel network and tap into theirs. An angel network – or syndicate – is a group of investors who regularly meet to discuss, review, and invest in startups often through a pitch night, demo day, or similar.
- Send great deals to other investors. Angel Investors and VCs are always looking for high quality deal flow. If you send a few winners their way, they are likely to return the favour.
- Add value. If you build a reputation of adding value, the best founders will often come to you. This can be anything from niche expertise, a few introductions, or just a coffee and a shoulder to cry on.
Now the tough decisions begin. In order to figure out which companies to invest in, most investors have a structured diligence process. A typical process will contain the following steps:
- Screening. The investor spends 0-30 minutes reviewing and researching an opportunity to see if it sparks interest, matches their criteria, and could fit well in their portfolio.
- First Meeting. If the company looks good on paper, the investor will do a first meeting either in person or via call.
- Research. If the first meeting goes well, the investor will do some more research and ask the founder a number of additional questions.
- Follow-up Meeting(s). If the research phase goes well, the founder is invited to a follow up meeting or meetings to discuss deal specifics, terms of investment and future plans.
- Due Diligence. At this point, the investor may commit to invest – conditional upon satisfactory completion of due diligence. The investor may create and demand completion of their own due diligence process or accept the process set by a lead investor, fund, or founders themselves.
Your investment funnel for a single calendar year might look something like this: 2000 screened, 500 first meetings, 300 further research, 150 follow-up meetings, 25 due diligence, 10 investments.
The alternative option is to join an angel fund or syndicate and invest alongside a group of investors on a deal by deal basis – outsourcing the deal flow to a syndicate lead or fund manager. It is recommended to still meet the founders at least once before investing to ensure your ambitions align.
Deal flow is now in place and you’ve created a filtering process that best suits you – but what are you actually looking for? Here are some things to think about when reviewing startup investment opportunities:
- Founders. It takes great people to build great businesses. What is the founding team's composition and strengths? What are the founders' backgrounds? How long have they known each other? What are their individual strengths and weaknesses?
- Problem. Investors must take a critical look at a business from the perspectives of the end customer. Would the product or service be something they really need today and would it help them solve big pain points with established budgets? If so, proceed – full steam ahead. If not, you could end up investing in a low revenue business that will most likely need to pivot into a bigger market opportunity.
- Solution. With every problem come countless potential solutions. How much better is it than its existing solutions? How much cheaper/more expensive? How long will it take to bring the solution to market?
- Market. Is the target market big enough for a high growth startup to flourish? How competitive is it? Is it fragmented or are there a few dominant players who could cause problems in the future?
- Business Model. How does the business make money? Do the unit economics make sense? Have the founders proven they can sell the product/service at the suggested price?
- Funding. How much capital is required to bring the product to market and scale? Is this the only round of funding required? Is there a risk that the company may fail to raise further capital in the future? Is your equity position likely to be diluted?
- Red Flags. Have the founders been completely honest throughout the process? Are they fully committed to this business or do they have backup options? Has a big competitor recently made a move into their niche?
It is unlikely you will ever find the perfect early stage business; however, it is important to consider these key factors before investment. Early-stage startup investments are risky. Most startups fail and it is difficult to pick the winners at an early stage with little data to support your intuition.
Each investor tends to weigh their options differently. Some would prefer to invest in a stellar team with a good product, some the opposite. A stellar team and a stellar product would be ideal, but that's unsurprisingly rare. As an investor it is important to decide what factors are most important to you and you’ll sleep well at night, confident you have built a portfolio of potential stars.
By Daniel Tait