What tech investors look for – 6 great VC’s in the hot seat!

Figuring out exactly what early stage VC’s are looking for should be obvious right? Like every other investor they are looking for a good return on their investment. Only problem with startups is just that they don’t have the usual data needed to assess wether or not this is the case. Since there is a whole jungle of startups out there, only the ones communicating clearly why they are a good investment will end up getting funded.

“So how do investors evaluate whether or not you and your startup might be a good investment?”

They could undoubtedly be looking at many different things like: Complementary skills within the founder team. A certain business model. A certain amount of traction. A blue ocean market. An idea that seems more crazy than usual or simply that “X” factor. Instead of wondering let’s find out by asking the investors themselves.

In this blogpost I ask the questions and 6 top VC’s answer. The participants are:

David Rosskamp Earlybird
Harry Briggs Balderton
Simon Menashy MMC Ventures
Max Niederhofer Sunstone Capital
Adrian Lloyd Episode 1
Lasse PilgaardCreandum

Let’s start with the basics by figuring out if there are specific areas that investors are currently looking for. Are there trends, waves or in other way spaces that are hotter than the rest? Lets find out by asking:

1. What spaces or business models are you especially interested in and why?

Lasse starts the conversation: “We invest quite broad based on where we find strong entrepreneurs – however are currently seeing very interesting startups being building within SaaS, Marketplaces and Games.

SaaS is interesting as you are able to create great value while having a somewhat stable cash flow. If the companies build a strong product, have good sales execution and ensures low churn – then it is ‘easy’ to build a good revenue base. Exits are the biggest problem with SaaS companies as it is often only possible to exit through an IPO for the #1 player.

Planday is an example of a SaaS company we have invested in that has done fantastic.”

Adrian adds: “I agree SaaS is an old hat now, but still great because recurring monthly revenues are awesome.  Businesses requiring massive volumes of users (i.e. very low price points) turn me off given how fickle consumers are. Hitting that jackpot is so unlikely. So we tend to bias towards enterprise businesses or B2B2C.“

Simon continues: “We are also currently backing a lot of SaaS businesses, but focus on fintech and B2C digital businesses too. These are ecommerce, online marketplaces and consumer convenience. We like businesses that are helping large companies to cut through the complication in ad-tech and digital media.

David nods: “Anything Enterprise SaaS as I see so many fields where little change has happened over the last decades. Old software regimes retain primacy and smart people will change this.

Likewise, and often in conjunction, business models with strong network effects (i.e. demand-side economies of scale) and low / decreasing marginal costs. These are often SaaS platforms or mobile networks that allow for global, exponential and sustainable scalability. We also invest in fintech on all accounts, from private finance to new forms of intermediation.

Lasse gets back at it: “The other two spaces I mentioned earlier were Marketplaces and Games. Marketplaces tend to be the big venture bets. Opportunity to build very large and valuable companies – but at a high risk as it takes a lot of money to build local market places. Autobutler and Vivino are examples of market places we have invested in recently in Denmark which are both investing heavily to become #1.

“Games are somewhat the unicorn right now in VC investments.”

After large successful gaming companies have been built in the Nordics (King, Supercell, Rovio, etc.) everyone is looking for the next. Investing in Games however is like investing in pharma companies – high potential payoff but also high probability of a zero payoff (also a general description of venture investments).

Adrian adds: “To give you a general idea. We like to focus on unsexy businesses that don’t get a ton of attention (….enterprise) and thus don’t get bid up to ridiculous prices.”

Harry wraps it up: “I like entrepreneurs who are doing something in an area they’re passionate about – something that’s hard and that few other people are tackling.  It isn’t about the latest “hot” space.”

 2. Do you invest at a certain stage?

Simon starts out: Yes – the space post seed but pre large growth capital (so Series A and pre-Series A). There is a lot of seed finance available in the UK, and a growing base of European growth capital providers adding to the established list of US funds, but the space in between – where a startup finds product-market fit and becomes ready to scale – remains under-served in the capital markets and we think there’s a lot of opportunity here.”

Harry, Lasse and Max agrees: “We do mainly Series A, but if it is interesting enough we also do the occasional seed or pre-Series A.”

David explains: “Earlybird covers Seed, Series A and Venture Growth stages, guaranteeing full financing for high-growth companies”

Adrian comments: “We are very reactive to our deal flow – we take each business as it comes and if we like it we pursue it, without putting it through any industry filters.  Our principal filter is: are you generating revenues. They can be very early revenues (from as little as £5k/month), but we like to see that you have been able to sell something to someone sensible out there.

 3. Since team is everything, what is the top three things that indicates a great team and how do you assess if a team has those skills?

Lasse starts out: “The first and most important thing we look for in entrepreneurs – are drive and energy. Within minutes after meeting someone you feel whether they have the ‘X-factor’ which is difficult to describe, but is really centered around drive and energy.

“Often the best entrepreneurs are also the ones that might seem a bit crazy – but not too much!”

Furthermore we look for teams that either has the right balance of skills within business, sales and tech or for entrepreneurs who we are confident can attract the right candidates. For early startups the right balance is most important, while for later the ability to recruit becomes more important.”

Max agrees: “Exactly, you need a team that shows the ability to attract, manage and retain great people.”

Adrian elaborates: “I believe you need a strong CEO who can hire great people and assessing this can be done simply by checking whether they have hired exceptional people around them. It needs to be someone who is a visionary and able to make important decisions well and fast. This can probably be assessed by interviewing subordinates.

Simon adds: It doesn’t need to be a filled-out team as long as they are open about their strengths and gaps and open to bringing in suitable talent to fill those gaps.

Adrian comments: “I completely agree that you need great people who have clear, non-overlapping roles and trust each other to do those roles without having to have a committee every time an important decision is made. It’s also VIP to invest in a “tight” CEO who isn’t going to over-spend because you almost always get close to running out of money.

Last but not least you need someone who has integrity, is honest and able to form relationships easily with his or her Board.

Simon adds: Yes, you need a team that has integrity and trustworthiness and that you feel would be a good long-term partner across both positive and negative situations.

Besides what’s already mentioned I also believe you need a team that has a good understanding of the key metrics that will drive the success of their business, and ability to articulate this clearly. Last but not least they need a healthy respect for the customer and the quality of the customer experience.”

Harry comments: “I look for people with a clear vision of where their industry is headed and the role they’ll play in it. People with a history of taking on really hard problems and delivering surprising results. People with infectious enthusiasm and energy. To assess this in a one-hour meeting is never easy and open to all sorts of biases – but for me the key question is, “would I give up the best years of my life to go and work for this team on this project?” – if the answer’s yes, that’s pretty telling”

David elaborates: “Lets have a look at the macro perspective or what I call intellectual scope.

Intellectual scope denotes the grander vision of the team and its ability to form a compelling narrative for a product that ultimately results in the creation of something remarkable, sustainable and big.

“Many teams, in spite of being bright and brilliant, lack this ability and focus on niches”

They often oversee or misinterpret the overall position of their product in a larger industrial evolution or are just executioners. The ideal team has a global and broad perception, and rightly positions the product within that. An intellectual ability to create a global and internationalizable product (and the accompanying vision) is key for me – local or regional solutions won’t cut it.”

Lasse continues: “So to assess whether or not a team has what it takes we look at experience and track record. However this is not as important as ‘X factor’ or the right skill combination. We would rather invest in very good DNA with limited experience, than more questionable DNA with a lot of startups experience.”

Adrian wraps it up: “All the things that have been mentioned are so easy to look for in theory but so much harder in practice. Entrepreneurs can come across as one thing in pitch meetings and pre-investment meetings and turn out to be something quite different once you really get into the business post-investment.  It’s very hard to read people based on a small number of meetings over a few months, no matter how good you think your judgment of people is.

So, part of the answer is to meet a team early (i.e. before you would ordinarily invest) and if you really like them try to spend as much time as you can with them over the months that they are building up to a startup into which you can invest. Pretty impractical in our very very busy lives, but the best thing to do. However, there is a question to answer here.”

4. What did the best startups you have invested in have in common?

Lasse explains: “They were attacking a large market.

“The founders of Spotify did not have a working product when we invested” 

– however, we saw two great entrepreneurs that were attacking a huge market dominated by incompetents – the music industry.

Harry puts it simply: “They were great teams who executed unbelievably fast and kept learning and shooting for the stars.”

David continues: “A gigantic market to change as Lasse mentioned. The most successful of our startups has had a technical, driven and visionary team with a global perspective beyond the first level use case of their product.

Simon adds: Besides what have been mentioned then a strong Board with highly relevant experience around the table and a startup that has raised the right amount of capital at each round.

Max concludes: The best startups had passion, persistence and ambitions.

 5. What is the number one thing during conversation/due diligence that might make you pull out of a deal?

Adrian starts: “Dishonesty and exaggeration are a showstopper. If you are stupid enough to be dishonest with an investor who is going to do a lot of due diligence into your business, then you are too stupid to be invested in. If you exaggerate to an investor who has a lot of experience doing due diligence in your industry then you’re (a) stupid and (b) unlikely to be honest in Board Meetings when things aren’t going well.”

Max comments: “Yes, a classic red flag is any indication of a lack of integrity or honesty, including misrepresentation, fraudulent or unethical behaviour.”

Lasse explains: “We always do background checks on founders to see if they are ‘clean’ – if not – that is a deal-breaker. Another one is founders that are not prepared to build a large company but would like to exit early.”

Harry agrees: Exactly – someone who says they just want to sell out in 3 years time for £20 million.

Simon adds: “If the key metrics of the business or the size of the market don’t stack up once you get behind the headlines. Or if it became clear that the founders were not people we wanted to work with, but fortunately thats a very rare case.

 6. What type of startups that might end up getting funded elsewhere don’t you typically invest in and why?

Simon opens: “We typically don’t invest in pre-revenue businesses, even if we’re super impressed. It’s always tempting to stray outside your investment strategy when you’re excited about something, but there are lots of opportunities where we do invest (early stage and Series A) and only so many deals our team can do at once, so it’s important to stay focused. We do our best to stay in touch with good startups as they develop and hopefully we can work together at the right stage.”

Lasse continues: “Some funds can live with a smaller upside potential than we can – meaning that local hero’s winner might end up get funding from seed investors or angels as it could yield a return of 3-5x, but likely not +20x that we are looking for.

“We can invest in European winners as we did with Izettle, but they need to be able to claim a large enough market.”

David specifies: “Typical cases are e-commerce startups. We would not invest for reasons like: the lack of technical DNA, the difficulties of differentiation and defensibility, the diseconomies of scale in classic e commerce models or the relatively low capital efficiency. Others, however, do invest as they weigh factors like proven business models, risk aversion or the trend towards online retail much higher. “

Harry adds: “Every investor, hopefully, has a slightly different perspective of a company.  We invest in the ones we’re really excited about and that we think can build really big industry-changing companies. We don’t invest in the ones we’re less excited about. That’s it, really.

Max wraps it up: “We don’t like serial entrepreneurs who raise massive institutional seed rounds pre product development.”

Hopefully this interview gave you a good overview of what investors are focusing on these days. To add to the conversation let me conclude with what I personally look for as a relatively inexperienced angel investor.

1. Commitment
The first thing I look for is how committed the founders are to taking their idea all the way. Building a startup is a very bumpy ride and I have seen many teams put down the fight and go start the next thing or just go back to their normal jobs. To assess the team, I always ask early startups to reallocate and join an incubator. If they are willing to do this they have passed the first test.

2. Go getters
I believe execution is everything and you need take initiative and to get out there. So many teams iterate the product a thousand times instead of just putting stuff out there and try to hack their way into traction. Real hustlers can get customers on day one.

3. Industry experience
I prefer backing founders that have been in the industry for a couple of year and who have seen how ugly business can really be. They won’t be as naïve as founders fresh out of school who believe everything can be derived from theory.

Thats all there is to it. Now go get that big fat check!

 

 

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