Where you typically invest:
You typically invest in an angel round (up to $100K in investment in up to $500K of a round). You want to see that the team has as massive market ($1B+ if you’re investing equity) and has initial traction (100 customers if B2C, 5 customers if B2B).
Common questions you should consider asking in due diligence:
What’s your human capital plan?
Who are you going to hire and for what? (The founders are likely very talented, and one of the biggest risks at this stage is that the team can’t maintain the same quality as the founders. The founders who have the best idea of who they want to hire–even specific names!) are the most likely to succeed.)
Tell me about your unit economics.
What is the lifetime value of each customer? What are the sales cycles? What are your renewal rate? What does it cost you to acquire a customer? (The founders who know who are the most valuable customers, how long it takes to sell, and how likely they are to renew are most likely to succeed.)
Tell me about your feedback cycle.
How are you getting feedback from customers? How are you measuring customer engagement, success, referral rate?
What your your key metrics?
How are you measuring if you’re successful? What is the positive impact you’re trying to have on each customer (cost savings, speed, social/environmental impact) and how do you measure it? (The teams who have a clear “before and after” value proposition are most likely to be successful.)
Blind spots you should be aware of (and might help you find better deals):
Many founders who didn’t go to great schools and aren’t well connected may not have an idea of how to build their teams. If a founder doesn’t know how to hire or add to their team you might want to consider whether the problem is the founder themselves or the networks the founder is in. If it’s a great founder who’s poorly networked, you as an investor can solve that problem.
Sometimes founders over-focus on financials across the company (a big Excel sheet) and under-focus on financials at the unit level (are we making money on each individual thing we sell?) Make sure at this stage your discussion around financials is at the unit level and not over-rating a big Excel sheet that is likely highly speculative, anyways.
- Smoke and mirrors:
Very often founders from certain backgrounds over-promise and under-deliver market size and projections. For example, men tend to promise bigger market sizes and bigger revenues than women do. Don’t make decisions based on the numbers that the entrepreneur is sharing with you, or how well they pitch; make decisions on the logic behind the numbers they’re sharing with you.
Where you can add the most value to entrepreneurs at this stage:
Help entrepreneurs understand the caliber of team you’d expect to invest in, and have them think through who they would hire if they raised money from you. They should be spending most of your investment dollars on their team, so spend far more time helping them think through how to hire–and who to hire–than any other topic.
Tell entrepreneurs that a large financial model doesn’t matter; a deep understanding of their economics at the unit level does (sales cycles, renewal rates, marketing/customer acquisition costs.)
Tell entrepreneurs that projected market size (“If we can get 1% of a $300 billion market, we’ll be a $3B business) doesn’t matter. Market segmentation matters far more. What subsets/segments can the entrepreneur be particularly successful in?