Note: A version of these piece also appeared in VentureBeat
I recently retired after working for 40 years in leadership roles at publicly held companies where my fiduciary duty was to my shareholders; I operated with the view that their, and my, objective was to deliver the highest possible return to my investors, without engaging in anything illegal or unethical. While I balanced short term results with long-term value creation considering my community, customers and employees, I always prioritized my shareholders. While each of them had their own priorities, foremost among them were company profitability, growth and share-price appreciation.
As I started investing in startups, I decided to create my own criteria and priorities. This led to a balanced approach that equally weights four criteria, with the goal of investing in opportunities that score well across the board. While I am not advocating this approach for everyone as investing is never one-size-fits-all, by sharing my thinking and criteria I hope to inspire you to come up with your own set of priorities.
The ultimate test is how my investments perform, meet the criteria over time, and deliver attractive financial outcomes. As only one investment has had an exit so far, I can only gauge the performance of the rest based on interim indicators of success or failure. I can also compare the performance of investments using these criteria against those that I made solely to achieve outsize financial gains.
- Are the products or services delivered going to benefit the customer? (e.g. improves the lives of customers, reasonable pricing)
- Is the business model going to benefit the community? Are there potential harmful effects?
- Is the business likely to generate an attractive return for investors? (e.g. profitable, growth prospects, competitive advantages, driven or seasoned management)
- Are the business leaders committed to creating a great environment for their employees? (e.g. employees treated as valued team members, supportive work environment, diversity practices, success trickles down to employees)
How I used these criteria with real examples of a few investments:
Opportunity A: A startup taking an innovative approach to education for autistic children, founded by a friend with a passion for creating a better world for those with autism and success in starting, growing and exiting a company in the financial analytics space. The startup aimed to succeed by leveraging the latest academic research and deploying software and animation tools.
Opportunity B: A startup aiming to incrementally innovate in the mortgage space by combining traditional approaches with new fintech-type technologies and offshore processing that would speed up the process, simplify the customer interfaces, and reduce origination cost and errors. The founder had proven experience and a history of successful incremental innovation in the traditional mortgage lending space.
Opportunity C: A relaunch of a failed curated produce and grocery delivery business with a newly hired CEO; the startup had initially raised and overspent a lot of capital, overextending itself. The market for food delivery was attracting new entrants and a couple of players were starting to gain dominance. The new CEO had experience in the industry and promised to fix the mistakes made by the earlier executive team and narrow down the business model while reducing the burn rate.
Applying the criteria to startups with limited information and little or no history – except in some cases the founders’ previous track records – required a lot of judgement and may seem arbitrary at times. I initially tried to rate each investment “High, Medium, or Low” but ended up modifying my approach to rating the first two as “Yes” or “No” — trying to avoid business that would only succeed by taking advantage of less sophisticated consumers or be negative for the community (or country) at large. I also introduced an “Unclear” rating, rather than force a conclusion where one was difficult to draw. Ultimately, the evaluation served more to help me organize and structure my thinking than by itself leading to an investment decision. The exercise proved valuable when combined with investor presentations, financial and return projections and conversations with the founding teams and other knowledgeable experts from my network. Nobody said this was easy.
Below is the performance of these opportunities, again keeping in mind that it is not over until it is over (meaning an IPO, an exit or a failure):
- My investment decision was heavily driven by knowing the founder and social good considerations.
- The company’s projections fell short and new money needed to be raised to continue. The new money, under the circumstances, came at terms unfavorable to the first-round investors.
- I invested in the second round based on (a) my assessment of the potential going forward, and (b) because I felt that I had a chance to recoup my initial investment.
- The company is now doing well and I am hoping for an exit in the next couple of years with a 1 to 2X return.
- Conclusion: I would still invest, but a lot less than I did. The nature of the business, from developing products, hiring the right people, and mastering the sales process turned out to be difficult.
- This is one of my largest investments, early and then alongside highly respected private equity money that came in as the company’s model proved itself and stood in contrast to other struggling fintech startups in the same space.
- Steady success from the start – perhaps not dramatic enough for those who funded other potentially disruptive, but at this point less successful, startups.
- Ironically, this company initially had a challenge in raising money because the founder was a seasoned and proven executive.
- Conclusion: This is a difficult business with economic cycles and intensive competition but so far, I am happy with the size and prospects of my investment.
- I invested after meeting with the new CEO and appreciating his approach to turning around the company; it’s difficult to understand why startups in non-tech spaces do not manage the burn rate more carefully.
- Success from the start and in this case I benefitted along with the other rescue investors as the new CEO quickly reduced the burn rate and refocused the company towards critical success drivers.
- Conclusion: It could turn out to be my most lucrative investment as the company is growing revenues at an unbelievable rate. It is up around 10X in a short period based on new capital raise to fund the fast growth; wish I had invested more – a lot more.
Investing in startups can be risky and rewarding; thinking through carefully, seeking advice from those with experience, assessing the economics, and appreciating the risks are necessary but don’t guarantee success. One of the most critical factors driving success is the founding team. I now look for a combination of passion for growth and innovation combined with solid experience in dealing with the areas of challenge that lie ahead. An ideal team balances the mix of someone not bogged down with experience that would keep them from disrupting, combined with some relevant experience that can help navigate the maze of complexity without holding back innovation. For fintech, I find the need for experience on the team to be very important while for consumer products, less so, unless success depends on conventional distribution channels (i.e. stores) where relevant experience is critical.
Another complicating factor is navigating forces outside the control of the business. Managing factors in the control of the company is difficult enough, but navigating external factors such as economic and credit cycles or dealing with the changing demand for loans in the secondary market does require experience. For businesses that need in-house employees (vs. outsourced resources), previous experience in recruiting talent and scaling up can also be a differentiator.
Ultimately though, even seemingly great opportunities with dream teams may not succeed. I have learned to not overinvest in any one opportunity, only invest what I am prepared to lose, keep accumulating experience and insights, and that a portfolio of carefully screened, non-correlated investments may produce the best results. You can listen to others, read about approaches and results but must realize that in the final analysis, you alone make the call and will bear the success or the failure.