Once again, for the eighth year in a row, I’m involved as an angel investor with the Willamette Angel Conference and screening investments. We’ll announce a decision in May, and between now and then, we’re looking at startups. About a fourth of them get what we call due diligence, and about half of those become finalists, which means even more due diligence.
Just in case you don’t know the term, due diligence is when investors research the startups. We read business plans, listen to pitches, talk to customers, look at technology, legal situations, and so on. We take several weeks. We divide into teams to do it. We have volunteer MBA students to help too.
With that in mind, here are 10 reasons I see for a startup not getting picked by angel investors. And to be clear, all of this is my opinion, and mine alone; I don’t speak for the group. I post this because I think it might be helpful.
Let me also clarify that not being a good candidate for angel investment does not mean a startup isn’t a great opportunity for its founders. It means only that it’s not a great opportunity for its investors.
My reasons here are not ranked in order. That would be too hard.
- Not enough growth. We see some very good startups that look well positioned to grow from zero to a million or so, maybe even two million, dollars of annual sales over the next three years. That’s enough growth to make the founders happy, but not enough to make a startup a good prospect to offer a return to angel investors.
- Exaggerations and simplifications. I’m surprised how often we see startups whose materials gloss over problems, forget to mention some hurdle that matters, or underestimate noise and competition. That doesn’t work. One such problem that gets caught creates doubts about everything else that was said.
- Not enough information. We’re looking for good information. We work with the gust.com angel investment platform that gives startups the opportunity to post video pitches, business plans, summaries, financial projections, and documents in Excel, PowerPoint, etc. We’re surprised how many startups fail to get us enough information. Having no business plan may sound good to the trendy types who say don’t bother, just do a lean canvas, or just a pitch; but not to us. We want the details.
- Too much competition. You can be a great business in a crowded, competitive market; especially when you do something different, and better. But it’s tough on angel investors and their return on investment when a startup is doing something that’s commonplace. We’ve turned down really good looking plans and pitches on catsup, growlers, baby bibs, and so on.
- You don’t need us. It’s quite common, actually, that we see good businesses that don’t need us or our money to prosper. If you can grow your startup without having to take on partners, and therefore you own it all yourself, then you’re better off. And if we invest, we take a minority share, and worry that if things go well you might not want to get more investment or exit, which leaves us with a minority share and no money. We want you to need our money in order to grow fast. What we get for our money is a share in your company and the only way we make money with that is when we can sell that share of ownership for money; which is what they call the exit. We don’t want to invest in the ordinary healthy company that pays its founders and grows but never sells out.
- You already know everything there is to know. In private conversations, discussing pitches after the founders have left, we’ll talk about the “teachable” factor. A founder who isn’t teachable is a disadvantage. Right or wrong, most of us have done startups before, and we’ve had some successes, and we think we can help as mentors. Some founders make it clear that they know everything. Maybe they do. But that makes us less interested in working with them.
- Growth not believable. You know the hockey stick phenomenon, right? The way startups pitching for investment always show a forecast that is about to shoot upwards? To some extent you’re damned if you do and damned if you don’t. If you don’t have a strong growth forecast, you’re hit the problem I listed as number 1 here, not enough growth. But if you do, it has to be believable. It has to be good growth, and credible. For that, check out what makes a sales forecast credible.
- Not scalable. Scalable means the business grow without the need for too many more services or more employees. Can you easily handle growth without losing quality? Does it take doubling head count to double sales? This might hamper the bottom line. Be sure to keep the future in mind. Angel investors like product businesses, or productized services, not service businesses. They want businesses that can increase sales overnight without increasing fixed costs.
- Not defensible. Angel investors want businesses that can’t be easily duplicated by competitors. They look for something proprietary, like trade secrets, copyright, trademarks, and patents. First-mover advantage is good but not enough. Is there a secret sauce? Are there barriers to entry? All this makes a business defensible.
- Doubts about the team. Risk is always a big concern with startups, especially for the investors. In fact, if you haven’t been involved in a startup or had some form of management experience, it could be close to impossible to find someone to take a chance on you. When you have people on board with startup and management experience, you are creating a team of strong leaders likely to build a healthy, marketable company. Don’t hesitate to reveal a failed attempt at a startup because it demonstrates you have experience and perhaps have gained some important insight.
And, with apologies for repetition, this is all just my opinion. I don’t speak for others.