Brief No.02 – The Investor “Minefield”
The Investor “Minefield” – The Risk Factors!
Continuing with our investor brief No.02. There is inherent risk involved in venture investing. Our years of experience teaches us that knowing the key risk factors – the investor “minefields” can help in establishing yourself as a successful angel investor.
Investing without any or limited access to industry knowledge. Sometimes, on the surface the opportunity optics looks good, yet understanding industry trends and evolutions is key to making smart decisions. If you invest in an industry you are not savvy in, seek advice from industry experts, it will reduce your risk.
Not vetting and or qualifying the opportunity appropriately. Before you spend time and money on the deal make sure it is a qualified opportunity for you, that is. Ask yourself the following:
- Does it fit my investment strategy? – Industry, sectors, region, etc..
- Does it fit my financial benchmarks? – Round size and check size and my investment goals
- Does it fit my investment horizon?
- Can I be an added value to the company in any way?
- Do I have confidence in the founder(s)?
Incomplete Due Diligence
Due diligence on an early-stage company is tricky. 70% of the decision is based on human calculations not financial calculations. In early-stage startups financial projections are speculation and guesstimations at best. The question is are you doing enough due diligence on the founder(s) and the people behind the company?
There is a nickname for Angel Investors – Affinity Investors. It refers to the fact that many angel investors invest in things they like or care about. It is not always a strategy for smart decision making.
Deal Term Dynamics
The deal terms are outlined in the deal “Term Sheet”. Although it is not legally binding, it serves as the document of understanding between the investors and the company and it can be a supporting document in the event of legal issues. We have seen on some occasions that there was a verbal understanding between the founder(s) and the Investor(s), yet it was not included in the term sheet and became a larger issue later in the relationship.
An investment strategy serves as your guideline, your “North Star” when it comes to making investment decisions. It will ensure that you are investing within your original financial benchmarks. When your core strategy is being compromised, it puts your entire investment portfolio at risk.
Trusting vs. Verifying
As humans we have a tendency to trust, or we want to trust. We can say something like; “He/She looks like trustworthy people” – “I will take you at your word”. Although it is not necessarily that anyone is trying to deceive you, it is just that some founders do not have the experience and they would like to be positive, it is adaniarable, yet risky.
Getting blinded by market hype and excitement vs solid data. In today’s media we are getting a lot of information, some which is very good and some which is very bad, depending on the data source. We sometimes get caught in the “Hype” which is being created by market influencers and special interest groups. It doesn’t mean that it is real and substantiated. It is a reality by virtue of agreement, which is not the ultimate test of reality. ( according to A. Einstein).
Letting other people make decisions for you. Sometimes I hear investors saying: “If it is good for X it is good for me”. You want to be careful. What is good for others is not necessarily good for you. They May have different financial benchmarks and goals and might be operating with a different strategy in mind. Unless you are 100% positive that the investors profile is similar to yours or that you know you share the meeting of the minds, think the same you might be led into the wrong path.
The startup founder(s) , by default, in many of the business cases always overestimate the market opportunity and undermine the market challenges. If overlooked you might be overpaying for the deal.
- It is what you do not know that you do not know that is your blind spot. Seek knowledge and expertise from credible sources.
- Make sure you fit the opportunity within your strategy and not change your strategy for the opportunity.
- Make sure you have 100% confidence in the founder(s) ability to execute, if not walk away.
- Separate your emotional attachment and invest based on the merit of the deal not be guided by your emotions.
- Any critical understanding needs to be outlined in the term sheet. If the term sheet is set, create a separate LOU and have the founders sign it before making the investment. Verbal agreement tends to disappear into thin air.
- Stick to your core investment strategy no matter what. It is OK to take a pass on an opportunity if it doesn’t fit your strategy.
- Take all the information with a grain of salt. Do not assume, verify. It will surprise you what you can uncover. After all it is your money, do you want to risk it on trust alone?
- Make sure you are listening to credible industry and market sources that are validated overtime.
- At the end of the day make sure that you make the decision based on your investors profile and your own strategy. You want to own your decisions and not be at the effect of them.
- Always use the “2.5X factor”. Cut the estimate by 2.5X times and increase the risk factor by 2.5X For example: if they estimated the market to be $500M take it as $200M if they estimate it will take $1M to get into the market estimate it as $2.5M