Startup investor pitfalls

I recently spoke to Fernando Langschwager about his startup, Aprendiendo.la.  After a short time, he looked at me and told me I was asking the wrong questions. For novice startup investors like me, it is easy to fall into the trap of evaluating startups from the wrong perspective.  I spent the rest of the chat with Fernando listening to his views on where I was getting off track and he helped me come up with three pitfalls startup investors fall into:

Pitfall #1: We don’t spend enough time evaluating the team.

Investor Bill Gross notes that timing and team are the top two determinants of startup success. A great team will find solutions, execute effectively, and achieve scale regardless of the current state of the startup or product.  But how can we determine what separates a good team from an excellent team?

Here are effective ways to get to know and evaluate teams over time:

  • Being a mentor or advisor
  • Having coffee with founders
  • Visiting a startup’s offices to meet the team and get a sense of the culture
  • Calling current investors
  • Talking to the startup’s clients about their interactions with the team

We can also get to know teams better by asking how they learn rather than fact-based questions:

Fact questions Learning questions
Where did you go to school? How long have you worked with your co-founder(s)?
How long have you worked in the industry? How many customers have you spoken to last week? What are you learning and studying to help you in your startup journey? What are your weaknesses and how are you addressing them?
What is your current business model? Can you tell me about the different iterations of your business model and how you decided to focus on the current one?
Who is in charge? How do the co-founders divide responsibilities and make decisions? Who do you seek out when you don’t have answers or are looking for direction?

Pitfall #2: We think we are the target customer.

Investors often assume they are the target market (we rarely are) and focus too much on a startup’s existing technology rather than on whether or not the current solution is meeting customer needs.  Sam Altman and Y Combinator use the slogan “make something people want” to stress the point that we should be focused on solutions that address customers’ needs.

Here are some questions investors can ask founders:

  • What is your customers’ pain point?
  • When and how often do customers use the solution?
  • How do you get feedback from customers? How often?
  • What do your customers tell you?
  • What is your measure of whether you are making something people want? Have you measured Net Promotor Score?

Pitfall #3: We don’t adjust our questions to the stage of the startup.

We ask founders questions about scenarios that are too far in the future or more relevant for profitable companies with traditional business models.  We should be asking questions about current growth drivers and the value of each new customer.

Growth investments Seed investments in startups
What was your revenue last year? Can you tell be about the current number of active paying customers? What are the growth drivers of your business? 
What is your profit margin? What is the expected lifetime value of a customer compared to the cost of acquiring each customer?
Is your current business model scalable? At what point will you have a model that you will be ready to replicate? How will your team grow as the company grows? What resources do you need to enter a new market?
What is your revenue projection in Year five? What milestone do you expect to reach with this round? How will you get to 10x revenue growth?

I appreciate Fernando pointing out these pitfalls. Evaluating startups, whether as a mentor, potential investor or pitch competition judge, is new to many of us, and hard. Brad Feld’s advice in the Techstars Mentor Manifesto is to “be Socratic”.  Instead of jumping in with our preconceived notions, we should seek out the right questions and ask founders to help us learn.

 

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