Where you typically invest:
You typically invest in a heavy seed/light series A round ($100-$500K in investment in up to $2M of a round). You want to see that the team has a product or service that has survived a couple of sales cycles, and has initial evidence that customers are delighted by the product.
Common questions you should consider asking in due diligence:
What’s your human capital plan?
Who are you going to hire and for what? (They are about to outgrow the founders. For example, the leadership may have a clear understanding of how the market works, but they’re about to hit the point where the founder/CEO can’t lead all the sales and customer relationships. Who is the sales team, and are you convinced they can effectively lead without requiring the CEO to be a bottleneck? Who do they want to hire? If they can’t afford them-that’s why you’re investing!)
Are you out-selling and growing faster than your industry?
What is industry standard for a product or service like yours, and how are you outperforming? (The team at this stage should be aware of who their competitors are, what industry standard is, and whether they are on track.)
Tell me where you are scaling next.
What new markets are you entering? What new customer segments are you going after? How are you thinking about growth? (It’s likely that the company is doing very well in an “early adopter” market, but may need additional support and resources to grow. Without a clear strategy towards growth beyond this initial market–growth that you likely will fund!–the company will struggle to keep up its momentum.)
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.
The best founders almost always know their unit economics backwards and forwards, and know where their next dollar is coming from. The best founders often don’t have great financial models (the skill set for this is largely learned in banks, consulting firms, business schools). Over-focus on unit economics; under-focus on financial models.
- Exit strategy:
The founder at this stage might not know what an “exit strategy” is. If they’ve got strong revenue growth and traction, it doesn’t matter. You likely know how to navigate the private equity/merger/acquisition market better than they do. As the team grows, they will need to take that skill in house but this is one major piece of value that you can add.
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.
Help founders, if they don’t know how, get strategic partnerships with larger institutional players. Help them make intros at the C-suite or senior level with people that can shorten sales cycles. Particularly if you’re an expert in a specific industry, you can add value where others likely can’t.