[Update: an edited version of this post is now available on StartupSmart]
My good friend and mentor alan jones responded to my “Angel Investor Bill” post with a different persona - Ted. Ted is a highly paid professional interested in getting some tax rebate by investing in tech startups. The purpose of this post is to help the Teds’ without any startup exposure to filter out the noise and find the good deals.
Below are the five things I always look for in a good Aussie startup:
Team
People make things happen, great people make magic happen. When evaluating a team, think about what Niki Scevak always says, “Can this team get shit done? Why do they give a shit?” (the two shits principle).
I said team because it is harder to do it solo. Statistically speaking, founding teams of two are better than one, and four is too much. I like a builder + seller combo with good communication.
Startups follow a nimble “build > measure > learn” process (in no particular order). Without a tech person, nothing will be built. Without a storyteller, no one will get to hear about the product. Without good communication, no learning or discovery will happen.
Below are some common scenarios that I have seen:
Two sellers, no builder:
- Can spend one year trying to recruit their chief technical officer (CTO). You can invest after they get the tech person, or alternatively you can invest in their competitor that has been executing for a year, who probably has a big market-share.
- Can spend a shit load of cash engaging an agency for the prototype.
- Can spend a shit load of time coordinating with an offshore tech team on a different timezone (to save money), iterating until the offshore team stops responding to emails. Uh-oh.
Two builders, no seller
- Can build something so niche that only two people in the world (i.e. the two founders) will actually use it.
- Cannot articulate the problem or the product well, so no one gets it, hence no word of mouth, hence no sales, hence no money raised.
I like founders who are super inquisitive and curious, that’s how they are able to listen to their customers and build a 10x better product.
I like founders who are super obsessed with their product and care about customer success, that’s how they are able to build a 10x better experience and retention.
I like founders who are super resourceful, creative and hungry to win, that’s how they are able to connect the dots and build 10x better unit economics.
I like founders with a genuine connection to the problem they are trying to solve, that’s how they are able to persevere when things get rough.
I like founders who are honest and accountable, that’s how they are able to build a long-term relationship with their investors who will back them again and again.
Tip #1: Always look for high-quality teams with complementary skills.
Product
A good product solves a really painful problem.
If the problem is not painful enough, no one will pay for it. The decision makers probably don’t have time to even think about it, let alone searching for a solution.
I think most of the obvious + solvable + painful problems are all being worked on by different teams right now, some categories have clear winners, some are yet to be determined.
Some unsolved problems require deep vertical knowledge to identify. When the founders have worked in a particular sector for many years, and then leave their high-paying jobs to build a product that solves their own painful problem, things become very interesting.
There are founders that try to think of a bullshit problem to solve, only because they want to “do a startup”, raise some money and get some press coverage. I would encourage them to join a well funded startup solving a real problem instead.
Tip #2: Always look for products that solve a really painful problem.
Market
An awesome product solves a really painful problem for many people.
Startups often pitch with a $100 trillion market size and claim that they only need to capture 1% of that market to be really successful. Don’t fall into this trap, ask them how they would get their first 100 paying customers.
Encourage the startups to walk you through their thought process using a bottom-up approach, work out the rough serviceable obtainable market (SOM) for the next 12 months.
If the product is disrupting an existing market, is it 10x better, cheaper or faster than the current solutions. Otherwise, why would a customer switch to the new product?
If the startup is creating a completely new market, do they have enough money to educate the users?
Is the total available market (TAM) big enough? Will this be a super high-growth startup or just another lifestyle business?
Tip #3: Always look for startups targeting a really big and growing market.
Product-Market Fit
Product-market fit is the magical moment when the founders figure out how to get the right product into the hands of their target customers. Happy paying customers are more important than anything else in the early days, because they will bring more customers via word of mouth.
Angel investors can’t really judge whether the product is good or bad when they are not the target customers. It would be best to interview the happy customers and find out why do they love the product so much, look at the market sizing to see how many more customers will also want it.
Look at all the channels the founders are using to reach those customers. Does the return of investment of each channel make sense? Are they spending $1 to make 85¢ (everyone can, including me)? What’s the payback period like? Is there a scalable, repeatable and sustainable customer acquisition channel?
This is when I like to invest because product and market risk have been minimised, and I am mainly exposed to the execution risk.
Tip #4: Always look for startups with happy paying customers.
Plan
I like a team with a plan because they can focus and prioritise. A plan is the best execution path based on the information the team has today. The team can adjust the plan as they discover new information, because assumptions are worthless until they have been validated.
The main purpose of the plan is to evaluate if the team can build the proposed product and get it into the hand of their customers before they run out of money. Can they show enough progress to raise the next round of funding from later stage investors?
A plan is also important for keeping the team accountable. Are they executing well? What is the new market insight that made them adjust their plan?
Tip #5: Always look for a plan that makes sense.
The Australian startup ecosystem
Some people may criticise Aussie angel investors as old-fashioned and risk averse because we look for so many things before we invest.
Other ecosystems may be famous for pumping out unicorns worth over a billion dollar like there is no tomorrow. Their startups often achieve fast growth with high burn rates. The aggressive “push > markup > backfill” method has created a wave of “default dead” business-to-venture-capitalist (B2VC) startups, meaning that the startups will struggle when they can’t raise the next round of funding from the VCs.
The Australian startup ecosystem, on the other hand, is great at building “default alive” business-to-business (B2B) companies. Our startups often achieve predictable growth with efficient burn rates. Our success stories may be in the boring sectors that are not media worthy, but their valuations are backed by solid cash flows. This is partly due to the fact that we have really tight-arse and conservative investors who question the revenue model from day one.
Is “slow and steady” necessarily a bad thing? Time will tell. But I do know one thing for sure, when the winter comes, startups that can pay their heater bill will survive, just look at the Chinese startup ecosystem last July.
Glenn Gillen painted a nice contrast in his recent piece about the Australian startup ecosystem, after spending a decade oversea as a tech guy:
There was a common thread with most of these [Australian] “startups” though. They had repeatable and scalable business models. They were making money. Most of them were profitable, handsomely so in some cases. And most of them had achieved it early. Not after 10 years and 5 rounds of financing. Most were break-even profitable within 12–18 months. Some were bootstrapped and profitable almost immediately, either spinning out of existing companies or consultancy work.
Lack of funding
For the startup founders, if your startup ticks all the five boxes above and you still cannot raise money due to “lack of early stage funding”, I would suggest you to look around and hustle harder.
Here’s a list of funding sources thanks to AirTree Ventures. We have angel investor groups in most cities. We have Innovation Bay dinner in Sydney, Melbourne, Perth and Adelaide.
I often joke that the biggest early stage tech investor in Australia is actually our government, think about this:
- We have the Research & Development (R&D) Tax Incentive that cuts your development cost by 40%.
- We have the Accelerating Commercialisation (AC) Grant of up to $1 million for a novel product or service.
- We also have the Export Market Development Grants (EMDG) when you are ready to export your IP oversea.
With innovation as our national agenda and more initiatives/incentives coming our way, I believe it is time for our very capable Aussie entrepreneurs to really shine.
If you have exhausted all avenues and still no luck, maybe that’s because you suck at storytelling? If that is the case, you can email me your pitch deck at mr.rayn@gmail.com, and I will give you my honest feedback.
Stop crying, leverage on what we have and get back to work. That’s what strong founders do.
This is part 2 of the series:
- Deal flow
- Evaluation (this)
