5 Things I Look when Investing in a Startup

Since this is my inaugural post here, I decided it would fit the occasion to list the five things I value most in an startup investment proposal. What I say here is my opinion and mine alone. It’s the result of several decades in high tech, three years as an investor in a local Oregon angel investment group, some consulting in due diligence for venture capital, and my experience as founder and co-founder of successful ventures.

  1. Startup experience. I want to see people on the team who have been through a startup. There’s no good substitute for that experience. That doesn’t mean all founders have to be startup veterans, but I don’t want a team of only young first timers, and I don’t want a team of corporate types on their first startup. I want somebody who knows what it feels like to work in a startup. Having been involved in a failed startup definitely doesn’t rule anybody out in my mind as long as they can talk to me about what went wrong and what might have been better. I know the complaint about a catch-22 for founders who can’t get funded because they have no startup experience and can’t get startup experience because they can’t get funded.
  2. Respect for the exit. I don’t care that much about the specifics of the exit strategy, because things change too fast and exits are 3-5 years in the future. But I want the team to understand that the angel investors need a deal to offer some hope of getting an actual check back in the future, not just the satisfaction of a small share in a long-term healthy company. I want the founders to know that’s important, talk about it, and think about it. I don’t want to hear “we don’t care about an exit strategy because we want to do this forever.” And I don’t want to invest in teams that are surprised at the question or don’t know what it means.
  3. A great market story. When I hear about the problem or the need, what some people call the why-to-buy, I want it to be immediately obvious to me why this is a big deal. I don’t really care nearly as much about the detailed numbers as what market the deal disrupts and what it changes. I want to be able to understand instantly that this will affect a whole lot of people or companies, not because somebody quotes some research, but because I can see it as soon as I hear it. I’m talking about what Marc Andreeson calls product/market fit.
  4. Scalability. I like products and websites that can scale up and reach very interesting volumes without being dependent on head count or manual labor or customization and lots of touches. I don’t like services dependent on experts or professionals who walk out the door every night. I want something that can continue to sell in volume even while we all sleep.
  5. Closeness. I don’t mean necessarily geographically close to me or conceptually close to my experience (software, web, etc.), but one or the other. Like most angel investors I know, I like the industries I know, and I like startups that are close to me so I can drive to a meeting. I don’t mind physical distance if it’s an industry or business I’m comfortable with, and I don’t mind a new industry if it’s close by so I can get a feel for it by visiting.  I’m not likely to invest in something I know little about when it’s also far away.
  6. Defensibility. Whoops, the sixth item in a list of five? Yes, I couldn’t resist. By defensibility I mean expertise, design, differentiation, technology, trade secrets, and so on. Patents are nice to have — a good validation — but not if the founders trust their patents to protect them.

 
Which finishes my honest list of my top five factors. As you might guess, every deal is its own special case, and every rule of startup investment has plenty of exceptions. This list, however, is a good summary of what I’m thinking when I first look at a new deal.
 
All opinions expressed are those of the author and do not necessarily represent those of Gust.

Tim Berry , Founder, Palo Alto Software
September 13th, 2011