You may download a PDF of this article from: https://koorandassociates.org/wp-content/uploads/2020/02/how-do-venture-capitalists-assess-teams.pdf

The purpose of this document is to help startups understand how VCs (venture capitalists) assess founding teams.  Everyone has their own point of view.  I will share with you some research.

Research shows that the most important factor early-stage VC (venture capitalists) consider when it’s time to make the investment decision is the team.

• 53% of VCs believe the team is the most important factor.¹
• 64%% of VCs believe the team was the most important factor in their startups’ success²
• 60%% of VCs believe the team was the most important factor in their startups’ failure³

An analysis of the personality traits of the founders of 500 startups revealed 4 key traits correlated with success or failure.⁴

• Quick and decisive decision makers were the most negatively correlated with success. The most successful founders were calculated, deliberate, and focused.
• Compassion, consideration, and concern for people were negatively correlated with success. The greatest  degree of negative correlation with success was when the team thought the founders were people focused.   A startup founder needs to make many difficult, unpopular decisions especially those regarding the exit of team members.
• Self awareness is critical. The most successful companies had a very aligned understanding between the founders and the team members regarding each others traits.  The smaller the discrepancy between the founder’s self-awareness and the team’s perception of the founder, the higher the startups performance.  I read research that for large companies, there are huge differences between the CEO and C-suite perception of themselves vs the employee perception of the C-suite.
• Women founded companies performed better than companies with only male founders.

Have a calm demeaner when pitching to VCs.⁵

An analysis of how VCs evaluated pitches revealed that the finalists tended to have a calm demeaner.  Further study showed that VCs equate calmness with leadership strength.

California angel investors’ judgement as to which CEOs should go into due diligence tended to prefer trust over skills.⁵ Technical skill gaps can be addressed via training, hiring, and advisors. Character is hard to change.  The angels sought CEOs who were honest and trustworthy.

California angel investors’ judgement as to which CEOs should go into due diligence preferred CEOs who were open to new ideas from investors regarding ways to increase value⁵.  The angels did not want CEOs who refused to consider new ideas or refused input from the angels.

CEOs should view pitches as an improvisational conversation with investors, listening to questions, and even asking the investors what they think.⁵

 My own observations are:

• Gaining understanding of the points raised above requires meetings in addition to pitches, most likely in the due diligence process. Investors determine if they can work with the founders for several years.
• Many investors seek founders who are able to learn knowledge(e.g. about customer, the marketplace, competition, etc.) and skills (e.g. cash flow forecasting, key business metrics, technical skills)
• Most investors seek founders who demonstrate a deep understanding of the customers’ problems, the benefits, and the competition. I’ve seen too many founders first build a solution and then try to find out if customers actually have the problem and are willing to pay for it.
• Many investors seek founders who have some unique capabilities.
• Many investors seek startups with unique technology or a unique solution which cannot be easily copied by competitors.
• Successful founders tend to be brilliant, able to assimilate and analyze large amounts of information (both quantitative and qualitative) and focus execution on the unique insights they’ve gained.
• Investors, especially angel investors, vary in terms of the potential size of the market and company they are seeking. I’ve seen angels get excited about a company that has the potential to grow to $10 million in revenue per year.  Other angels seek the potential for $1 billion per year future revenue.

Your next steps

You must research each VC to understand how they assess startups.  All VCs are not the same.

Footnotes:

¹ Paul Compers, Harvard Business School, Will Gornall, University of British Columbia Saunder School of Business, Steven N. Kaplan, University of Chicago Booth School of Business, Ilya A. Strebulaev, Graduate School of Business Stanford, “How do venture capitalists make decisions”, April 2017, Page 42  This survey of VC firms included: 63% of all VC US assets under management, 9 f the top 10 VC firms and 38 of the top 50 50 VC firms.

²  “How do venture capitalists make decisions”, Page 53

³  “How do venture capitalists make decisions”, Page 54

⁴ Brittney Riley ,”How should investors evaluate founding teams”, Medium posting, April 24^, 2017 This is an analysis of the relationship between company performance and personality traits of 500 startups.

⁵ Lakshmi Balachandra, “How venture capitalists really assess a pitch”,  “Harvard Business Review”, May-June 2017

You may download a PDF of this article from: What is the value and role of a lead investor

How do you read this article?

• This article is written for startup founders.
• There are two examples of a lead investor.
• Then there is a generic description of a lead investor. The lead investor in your specific situation will likely be different.

Two examples of a lead investor:

The lead investor in an angel investor organization

• Produces the due diligence report. Consultants and other angels may have provided input to the report and carried out specific due diligence task.
• Negotiates with the founders on behalf of all the angels.
• Manages angels’ lawyers.
• Manages the angel close including getting the money into escrow.

The lead investor of a syndicate:

• Has prepared a due diligence report, completed a term sheet after negotiations with the founders.
• Then begins to actively recruit more investors to the deal.

What is the value of a lead investor?

• Without a lead investor, you may fail to raise capital.
• The reputation and network of the lead investor will attract other investors.
• Many VCs, angels, and angel groups will not invest until there is a lead investor.
• Including the name of the lead investor and terms in your pitch deck greatly improves your chance of success.
• Having a lead investor reduces the overall time and effort to raise capital.
• The lead investor will make a major investment, at least 15% of the round and sometime up to 50% of the round.

What may the lead investor do?

• Prepare a due diligence report. Subsequent investors may still decide to conduce their own due diligence.
• Negotiate the term sheet.
• Hire a law firm to handle the investors paperwork. Sometimes the startup will pay for some or all of the lead investors out-of-pocket costs.
• Sit on your advisory board.
• Sit on your board of directors.
• Make introductions to potential investors, customers, partners, suppliers, employees, and others.
• Help manage the other investors.
• Help structure future fund raising rounds.
• Participate in future fundraising rounds.

What are the characteristics of a lead investor?

• They passionately believe in you and your startup. They are not going to try to force you out and take control.
• You’ll be able to work with them for the long term. Divorce from a spouse is often easier than divorce from a lead investor.  Do you actually like the lead investor?
• Consider the investor’s values, morals, and ethics.
• They are respected in your industry and/or in the startup financing world.
• It’s helpful if the lead has been a lead before.
• They have invested before and those investments have done well.
• They have lots of funds for follow on investments and investments in other startups.
• They are not in any kind of financial distress.
• The investors have diverse portfolios so that market problems in one sector will not result in pressure on your startup to perform.

Look for the lead investor before you look for the follow-on investors.

• This can take a long time.
• You may make hundreds of phone calls and emails, meet with over a hundred people, and spend over 20 hours a week for three to nine months to find a lead investor.
• You need to build relationships with investors over time. You’ll need a plan, and a CRM, to stay in touch with them.

How do you find a lead investor?

• Build a target list of investors. A CRM is helpful.
• You identify targets from: other founders, advisors, people you meet, researching he lead investors from other deals, lists of conference attendees, The Canadian Venture Capital and Private Equity Association website (cvca.ca) , hockystick website (www.hockeystick.co) startup here Toronto website (https://startupheretoronto.com/startup-support/), the Angel Investors of Ontario website list the Ontario angel groups (https://www.angelinvestorsontario.ca/groups), http://www.crunchbase.com.

Your next steps

• Define what you are looking for in a lead investor.
• Set out you plan to find a lead investor and to stay in contact with the investors you have met.

You can download a PDF of this article from: How do you understand potential investors?

Why understand potential investors?

You will fail to raise capital if you:

• Don’t understand the investors needs.
• Don’t understand how the investors perceives how you meet their needs.
• Don’t understand how the investors perceive that you meet their needs better than others asking for capital.
• Spend time on investors who will never invest with you rather than spending time on investors who have needs you might be able to meet.

Or, as Karen Kelly of K2 Performance Consulting told me, “Don’t try to sell steak to vegetarians.”

The overall process is to:

• Document some hypotheses: What are the characteristics of a potential investor? What are their problems and needs?
• Document your hypotheses in the business model canvas¹. This framework ties together investors, their needs, your solution, and what’s required to build your solution.  Your business model canvas will change as your hypotheses change, are validated, or are invalidated.
• Test the hypotheses by interviewing potential customers. These are not sales calls.
• The interview process will either validate or disprove your hypotheses.
• During the interview process you will likely revise some hypotheses, as well as set down some facts (i.e. validated hypotheses).

Key Hypothesis for the rest of this article:

Let’s assume your target investor is the individual investor who makes decisions regarding some or all of their investable assets.  There would be different needs if your target was: the Chief Investment Officer of family office; the financial advisor who makes investment decisions for clients; or an institution investing capital.

 Why is a business model canvas critical?

Let’s pick a simple example to illustrate:

• You want to raise $10 million and you plan to do $25,000 asks from investor with investable assets of $3 -$5 million. You’ll need have 400 investors.  OR are you planning to do $1,000,000 asks from investors with investable assets of $100,000,000+? You’ll need 10 investors.
• Your channels, partners, resources, activities, etc. will be radically different for each of the above two examples.

A business model canvas will help you think this through.

What are some aspects of the target investor profile?

• Age?
• Gender?
• Location?
• Where born and where living now?
• Current income and occupation?
• Current net worth?
• Part of a high net-worth family?
• Supported by a family office, shared or dedicated to one family?
• % of assets managed (i.e. investment decisions made) by third parties vs made directly by the investor
• Associations membership e.g. Tiger 21 or Family Enterprise Xchange?
• Yearly living expenses – e.g. some potential investors may have fractional jet ownership?
• Future major expenses – this could range from several hundred thousand dollars to support a child in a foreign university, to a $100 million+ for their next yacht?
• Do they have a documented investment thesis?
• Do they have little time to manage their investments, are they devoting significant time to manage their investments?
• What is their asset allocation mix? Specifically, what % of assets are they allocating to the asset class you are part of?  Two examples:  1) You’re a fintech company using AI to analyze home mortgage approvals.  2) You’re an early stage Venture Capital fund investing in companies with women founders.

What are potential investor needs?

Investor needs can include social, emotional, and financial needs.  These needs may include:

• Being perceived by others as: a sophisticated investor, someone making a positive impact on society or a specific cause.
• Having the satisfaction of knowing they are doing good.
• Being actively involved and devoting time to managing their investment. They value the social interaction with other investors.  They value being a coach or mentor to the CEO, being on the advisory board, or being on the board of directors.
• This type of investment is a hobby.
• They are seeking a xx% probability of achieving YY% cash-on-cash return within ZZ years?
• They are seeking wealth transfer to their children and grandchildren.
• IRR is of little interest.

What value will the investor provide to you and your company?

Investors can provide value in many ways.  Some of the hypotheses in your business model canvas may include:

• Providing capital both in the short- and long-term.
• Enabling your capital raising by drawing upon their network of investors.
• Providing access to their network of potential channels, partners, suppliers, customers, and employees.
• Enabling your success based on the reputation of the investor.
• Being a coach or advisor to you.
• Serving on your advisory board or board of directors.

What are the dos and donts?

• Do document and execute a structured process.
• Do define your target investors and select potential investors who are representative. For example, if you are creating a venture capital fund which will focus on providing investor exits within 3 years, do not interview potential investors who seek a 20+ year exit in order to facilitate inter-generational wealth transfer.
• Do face-to-face interviews. Video calls are a distant second best.  Phone calls are a very distant third best.  Don’t do emails or surveys because those do not allow interactive dialogue and understanding.
• Do get out and interview lots of investors. The absolute minimum number of investor interviews is 10.  50 interviews are a better number.  You will have to contact many people to get the necessary interviews because most people will decline.  They are strangers with busy lives.
• Do ask potential investors if it’s OK to record the interview for later analysis. If not, have a second person take detailed notes.  Do not conduct a non-recorded interview by yourself.
• Do document the criteria for assessing the answers. This will avoid confirmation bias, in which you’ll ignore information which invalidates your hypotheses.
• Do not interview friends, family, or those you have a personal connection with. You need brutal honesty, rather than hearing from people who do not want to hurt your feelings.
• Do focus on the people who actually have the problem or need for which you are creating the solution.
• Do create questions which require quantitative answers or specific descriptions. Don’t ask for subjective or hypothetical feedback.
• Do create questions which help you understand how investors think, and why they take the actions they do.
• Do not talk about your company in your initial meeting.
• Do not use or send a survey form. These tend to ask closed-ended questions, while you want open-ended responses to open-ended questions.
• Do finish each interview with two questions: “Who else would you recommend I interview?”, and “What should I have asked but did not ask?”
• Do create a data collection form for each interview. This will contain things such as: the description of the investor profile, your open-ended questions, which hypotheses were confirmed and why, which hypotheses were invalidated and why, which hypotheses you gained no insight into and why, what changes you should make for the next interview (target customer profile, hypotheses, questions to ask).
• Do review and update your business model canvas as you validate your hypotheses regarding target customers and their needs.

Other ways to understand investors:

• Read research reports e.g. Tiger 21 reports.
• Document and analyze sales calls on investors.
• Interview your existing investors.

What are the challenges in interviewing potential customers?

• The FEC (Founders, or Existing Companies), passionately believe they have created right solution. They believe there is no reason to interview potential investors. They are focused on building the solution and selling it. Their passion results in them being unable to listen to, and understand, what the investors are saying.
• The FEC believe any sales and marketing problems can be fixed by changing the sales deck and changing the website.
• The FEC are passionate they have the right solution. Hearing brutal feedback from potential investors requires founders who are self-confident, self-aware that they don’t have all the answers, and have the ability to learn and adapt.  I’ve observed many people who are not able to learn and adapt.
• The FEC lack the personality and skills to contact a large number of strangers to setup and conduct interviews.
• Doing interviews appears to be lack of progress. Building a solution is more fun and appears to be progress.

Conclusion

You will fail if your investors do not believe your solution addresses their individual key needs.

 Footnotes:

¹ “What is a business model canvas?”  The following is a link to my article https://koorandassociates.org/tools/what-is-a-business-model/

This is an update to my 2019 Feb 22 survey, with additional findings and insights.

I did a survey of founders and CEOs of  startup software companies.  I asked them the question: When did you get outside investors, excluding friends and family?  After you had some satisfied customers who provided some revenue?  Before?  At some later stage of your company?

The key learning is that there are many paths to growing a software company

There were a total of 17 responses.  11 raided money from outside investors once they had a MVP (Minimum Viable Product) with some satisfied customers and some revenue, 3 never raised capital from 3^rd party investors to grow into significant sized companies.  3 raised money before they had any customers. Two of these conducted large numbers of interviews of potential customers (in one case, 300 individual documented interviews in one year).

Investors told me that they did invest in pre-revenue and pre-customer companies.  These were clean technology, medical technology, pharma, quantum computing, etc. i.e. not software companies.

Every investor told me that they don’t invest in the idea.  They invest in the people.  i.e. The world is filled with people with ideas, but there are few people that can actually create something.