Ep. #24 of the SouthFound podcast - What do investors look for in a startup?
This content was originally recorded for the SouthFound podcast, where I feature entrepreneurs and startups from the Southern United States.
What do investors look for in a startup?
When you are looking for investors to inject capital into your company it is important to be targeted with who you approach. Approaching investors that have no interest in your space or that haven't invested before at the level you need is a waste of your time. Think of this like the common Marketing topic of "target market".
Here are 9 things investors look for in a startup?
My good friend and CEO of Angel Capital Group, Eric Dobson, often tells entrepreneurs that between 50-70% of an investors decision to put capital into a business is based on the team operating that company. The thought process is that the idea can be a grand slam solution, but if the team can't execute the plan you will never gain enough traction.
Having a solid team doesn't mean you must have a fully developed organizational structure already in place. It is important for most startups to have both technical and business-minded co-founders (rarely are they the same person). There are some functions that you can outsource, especially early on. Things like bookkeeping, graphic design and legal work.
Some entrepreneurs cover their bases on skills their team is missing by having an advisory Board. Here they invite other entrepreneurs and professionals willing to provide their time (sometimes for free or in exchange for small amounts of equity) to guide the company through issues within their experience.
However you choose to structure things, just be sure that you have a strong team in place.
A great idea that solves a true pain point
Notice I did not say a unique idea above. Some of the largest companies in the world did not come out of unique ideas. MySpace came long before Facebook. Most people don't know that a company called Friendster exist- ed before even MySpace. Apple started by developing computers. IBM and others were already doing that. It isn't the idea that made them what they are today. It was the execution of a slightly different take on the idea.
One more point here - if your idea is truly that unique that no one is doing anything like it that means that there has likely been no demand for your solution. No demand equals no market.
Alright, let me get back on track...
Investors are looking for great ideas that solve pain points for which people are willing to pay for. If people aren't willing to pay for the solution then either it isn't that big of a pain or your solution doesn't solve it well enough.
Market size/market share
So, what happens when you have a great idea that solves a pain point that people are willing to pay for but there just aren't enough people experiencing that pain? Nothing happens.
Market size matters to investors because they understand that it is going to take a significant amount of growth in your company, and that means taking over enough market share from competitors, in order for the investor to re- coup their capital and get a good return as well.
Now I should note that there isn't a magic number when it comes to market size. A billion potential customers is great, but investors inject capital into companies with half that in market size. As long as they believe your idea can take over a fair amount of market share.
Patents, copyrights, trademarks oh my! Moving from left to right in that list respectively investors love, like, and are happy when you have intellectual property (IP) rights protection in place. Particularly issued patents. Provisional patents, meaning you have applied but the patent office has not officially approved your application, are good but not as strong.
You are most assuredly going to have copy-cat businesses that try to take your idea and either make it their own or make small changes to claim they are different. Having your IP properly in place (use a qualified attorney here that specializes in IP law) signals investors that your idea and their capital is well protected.
One note here - IP rights, much like legal contracts such as non-disclosure agreements, are only as strong as your willingness to spend legal fees enforcing them.
Barriers to entry
Things like intellectual property create a barrier to entry for other companies looking to compete in your space. There are other barriers that investors look for to help with combating competitors.
These include things like regulatory barriers. Let's imagine you have creat- ed a new pharmaceutical solution that will require FDA approval. If your company is further along in that process or even has already received FDA approval, it is going to take longer for any competitor to scale up.
Others barriers include political (think about entry into foreign markets) and economic (like a real estate solution that requires good housing inventory in a down market).
Skin in the game
Have no doubt that investors will ask if you have injected some of your own cash into your business. If you have then this will look favorably upon you. If not, it could cause investors to pause or pass.
This makes sense. Whether you have spent $5 or $50,000 on getting your company rolling, investors like to see founders who are taking on risk with their own capital. The more risk the better. If you aren't willing to invest in your own idea why should someone else?
A good deal
If you have ever bought something that you really didn't need because it was on sale then you understand the psychology behind purchase behavior. While smart investors won't throw "good money after bad", investors do like good deals. After all, they are looking to maximize their return.
Your idea and team may be enticing. But sophisticated investors are seeing hundreds, if not thousands, of good ideas and teams. If they compare two companies where one company is offering more equity in return for less cash they are likely to go that direction.
Make sure to do your research and structure a deal that is fair to all parties involved.
Other investors are playing
Investors are often attracted to companies when others have already in- vested in them. The old saying of "where there is smoke there is fire" holds true. If well-respected investors are supporting a company then this signals to other investors there is something worth looking at.
Herein lies one of the benefits to landing experienced investors. They tend to attract other investors. This is one reason to be targeted with the investors you plan on approaching.
The value that investors place on your company will partially be driven by the number of milestones you have accomplished. We call this traction. And the earlier you gain traction the better.
Milestones can be things like a number of users, issued patents, and paying customers. Milestones not only increase your value, but they also attract the attention of investors.