Winning Early Stage Investors by Anticipating What Angels Want to Know
By: James H. Sherman (MBA '91), External Relations Co-Chair, HBS Alumni Angels of Greater New York (author of Smart Startups – What Every Entrepreneur Needs to Know; Advice from 18 Harvard Business School Founders. To be published in Oct. 2023, Harper Collins).
When you are starting a company and getting going, you should put not just your entrepreneur’s hat on but put yourself in the shoes of a potential investor. Understand early on what an investor is likely to focus on for evaluating your early-stage business. Afterall, you are in the business of selling risk and the investor is buying risk, in exchange for a return on their investment.
Consider these 4 crucial issues which any potential investor is going to assess.
1. Are you solving a meaningful problem or satisfying a meaningful need?
Perhaps the biggest pitfall for entrepreneurs is that they do not sufficiently demonstrate that they are solving a market need. During the early stage, you don’t have many, if any, customers so there is little market feedback. But investors want some evidence that the business you are building is going to work. So, you must think creatively about how to demonstrate this; how to provide that evidence.
To the extent the venture is solving an explicit problem (e.g. you found a cure for cancer) then investors may not need a lot of convincing. The large question for science or deep tech ventures is whether it works. But in most new business model situations, you need to provide more than proof of concept and need to show that not just some but that many customers want to buy your new product or service. Merely stating that you have a large TAM (total addressable market) is not sufficient.
It is crucial to understand that a “large market” does not equate to “large opportunity.” The question is what offering you are bringing to a market (or are you creating a new market). This is the crux of assessing whether you are tapping into a large opportunity or not.
2. Are you riding a wave?
Investors love momentum stories. While it is possible to launch a business in an existing mature market by offering a product that is better, cheaper, or more convenient, investors love a momentum story where there may be several winners and the focus for them is on which few will succeed. Are you tapping into an emerging technology, a new consumer or business trend, or changing demographics?
A slew of new online publishing companies rode the wave of Internet 1.0. Later, with rise of Google, e-commerce companies that leveraged search engine marketing grew rapidly. Then, the rise of Facebook and Instagram led to another wave of innovators in e-commerce leveraging social media marketing. The smartphone gave way to new brands enabling all sorts of conveniences made accessible from small software programs or apps. Today, the rise of AI powered generative text and images is going to power new business applications. Or we read today about the advent of the metaverse and blockchain and how these are spawning further innovation. If you venture is riding a wave, investors want to understand this. But beware, by the time you observe a wave, it is often too late. Your business needs to have already been on it to be successful.
3. What are the building blocks of the business model, and can YOU pull it off?
It isn’t enough to convince investors that your company is tapping into a large opportunity. You need to demonstrate that you understand very well the business model and what the cornerstone bricks are required to build it. If the venture needs a key operating partner, do you have this? If the venture is a consumer play, have you demonstrated that you have a unique way to efficiently market to consumers? If you’re going after the enterprise software market, do you have a marquee customer already lined up?
You should anticipate the business model questions that investors will have and be prepared to address these.
4. What are the unit economics of the business?
Entrepreneurs need to assess the gross margins and operating margins for the business – both at the venture’s start and at scale. Are your assumptions reasonable? Margins and timing of revenue (when cash comes in) are crucial. These will dictate much of the financing requirements for the venture. Investors want to know if you are going to need $5M to get to break-even or $50M. In addition to any capital expenditures, your financing strategy is greatly influenced by the venture’s unit economics. Many businesses make assumptions that turn out not to be true. So, investors want to understand how well you have vetted your assumptions.
Equally important, they want to know if you have a quick means to get to break-even if fundraising conditions rapidly change down the road. Investors know all too well that the funding climate is not static. Should your venture face a financing crunch in the future, investors like to know that there is a Plan B to get to break-even.
Of course, there are more considerations on the mind of angels. What is the competitive landscape for your venture and are you able to create a competitive moat? How fast can you build the business? What is the traction to date that demonstrates some proof points?
Additionally, there is one other criterion an investor evaluates in the back of their mind throughout – that is “founder fit.” Investors want to understand what skills you have that fit with the opportunity. While most investors recognize you do not have to come from within an industry to disrupt it, it IS important to have certain skills that relate to what you are building. Angel investors need to be convinced that YOU are the right one to build the business!
Are you an entrepreneur seeking angel funding? Learn more about how to apply to pitch to the HBS Alumni Angels of Greater New York.
Author - Jim Sherman (MBA '91) - External Relations Co-Chair, HBS Alumni Angels of Greater New York (outgoing)
Jim is a serial Internet entrepreneur, angel/seed stage investor, and author. He founded and exited three companies -- WestEnd New Media in the late 90s focused on providing Internet strategy advice to media firms; ShermansTravel Media (2002 to present), a leading publisher of hand-picked travel deals, and Hamptons Lane, an e-commerce venture targeting foodies. He has deep experience in digital media, advertising & marketing, and e-commerce. His former corporate roles include strategy consulting (Bain & Co.) and publishing (Time Inc.; Pearson; Martha Stewart Living). He loves travel, the theater, and international politics.