Author: Abu Cassim
20 July 2020
Whether you are new to the angel investor field or are an experienced investor, there are various considerations to take into account when looking to invest in a startup. In this blog we explore factors that most angels look for in a startup. Each angel will apply certain preferences and nuances which may fall outside of this list – it’s important to find these preferences over time as an investor.
Offering an innovative product or service
Off the bat, the solution needs to stand out from the rest. A well-known analogy used within the investment industry is that investors prefer painkillers over vitamins. Vitamins look at an existing solution and find a way to do it better, while painkillers serve unmet needs. It’s said that a vitamin-like solution needs to be 10 times better than an existing solution to win over its customers. Switching is inhibited by inertia and friction because of customer anxieties and the cost of moving respectively.
It’s important for angels to interrogate the value proposition. Does it create a barrier to entry? Can the intellectual property (IP) be applied in other markets? Does the team have an unfair advantage over their competition? Disruptive tech is usually packaged in flashy wrapping. It looks good and sounds good but does it translate in to value being created for the customer and captured by the business.
Strong entrepreneurial characteristics and a great team
A good idea is never enough – ever! A great team is needed to execute on that idea. Angel investors would rather invest in an “A team with a B idea” than invest in an “A idea with a B team.” What exactly does this mean? Ultimately, a strong team is a must-have for the success of a startup and is more important than the idea itself.
Some of the desirable characteristics to look at when it comes to determining the quality of a team include the following:
- the technical skills and passion to execute on their plans;
- ability to adapt to possible opportunities and threats;
- complementary synergy together;
- startup and domain experience; and
- coachability. If you’re going to be working with the team, you need a workable relationship.
Market size and opportunity are some further important considerations for angel investors. Important to understand the unit economics that drive a business’ potential. How many people experience the pain point being solved for? How often do they experience this issue? Are there serious consequences each time they experience it?
Scalability refers to the solution’s ability to meet the demand potential. What is the marginal cost of servicing one additional customer? The lower this number the more scalable the solution is.
The traction of the business
The point on market opportunity (explained above) is very closely linked to the business traction – the progress that a startup has made and its momentum. How many users do they have? How many paying customers do they have? How often do users revisit? What revenue has been earned?
These indicators are dependent on the industry and external marketplace factors. The higher the traction, the greater the attraction to the organization for the investor. The reason traction is important is because it mitigates the risk of market adoption, which was identified as a key risk in one our previous blogs. This risk relates to getting customers, gaining momentum in the market and whether the offerings will resonate with the target customers.
How well does the startup fit?
Angel investing is a very human endeavour. We invest in people we connect with and in areas that we know and are comfortable with. As a result, most angel investors operate in a defined set of industries. Startups sell potential but if you’re not familiar with the space they are operating in that potential can easily be oversold.
A good understanding of the startup’s industry will allow the investor to leverage his or her knowledge and networks in this space, resulting in greater realised value for the startup and investor. Furthermore, there are obvious synergistic advantages to the startup being aligned with the angel investor’s current portfolio of businesses.
Return on Investment
An obvious consideration for the angel investor is the profit potential that can be created from the startup. Our average angel investment has been ~R700k for 15% to 20% in equity where a valuation is possible. Return targets are speculative but anything with potential of 20x to 40x will do nicely. The expected holding period is roughly 6 to 8 years but there are liquidity events at each subsequent funding round.
Although a financial return on investment is a vital consideration, some angel investors may want to enquire about the social return on investment. This relates to the type of impact that the business will have on its various stakeholders such as the effect on the community, customers or even the environment.
The various factors listed above will help angel investors when looking for and choosing the most suitable startup. You may want to consider other factors and add them, dependent on the industry or amount of capital you have available. These factors may include a preference for annuity income over transactional income and a preference for B2B solutions over other operating models. These are areas of comfort that are found over time.