10 Questions to Ask When Evaluating Early-Stage Startups
When George Damian presented the Anatomy of an Early-Stage Startup webinar, a lot of great questions came in that he and Movement51 Executive Director, Danielle Gifford, had a chance to answer live.
The mixed crowd in the Zoom room ranged from:
20% of attendees being aspiring early-stage startup investors
6% were active early-stage startup investors
32% were early-stage startup founders or co-founders
13% were ecosystem supporters (incubator/accelerator, consultant, educator, etc.)
29% were simply curious about the startup, tech, and innovation ecosystems
… which made for an engaging discussion that covered a lot of ground, digging into key factors to consider before investing in early-stage startups.
Recalling George and Danielle’s expertise shared during the session, here are the investor insights they shared in response to the top 10 questions.
In VC meetings, I don’t get asked very often to demo my product. Is a demo version important?
Depending on what you are raising, having a demo version is important. If VCs are investing in your product, they may want the opportunity to go in and play around with it.
But with that said, it's okay to present a framework or wireframe to show off what you’re testing out or what you’re using to test if what you’ve developed is the right feature set for what your customer might really want—emphasizing it doesn't have to be perfect. Having a recorded version of a demo that you can share is always a good idea. Loom is a great free tool that you can use.
Is this something that has enough features that your customers actually would want and can begin to attract them?
Beyond the demo, though, those meetings are often testing you. VCs may very well not dive deep about anything in the pitch deck, and oftentimes, they'll ask you to submit the deck in advance to measure how dynamic you are.
It's not unusual for a founder to go into a VC meeting thinking they're going to go and actually talk about their company. Meanwhile, the VC might say, “Oh, no, we've read the deck. We want you to talk about yourself now.” Traditional pitches may not suit their audience, and this can be a plus since telling your story can be more founder-friendly.
The main takeaway is to always be prepared. You want to be ready for any wildcards and flexible to show your product and control how that happens—all while keeping in mind that VCs are usually looking for something other than understanding the demo. They want to understand you as a person.
The webinar summarized an A team of four core members: a Hustler (business and sales lead), a Hacker (software developer), a Hipster (experience and design), and a Handler (product management). Would these A team members still apply if you aren't a tech company?
They might look different depending on what type of company you're starting and especially what industry you’re working in.
If you're starting something potentially in software, the mentioned team example is a classic software-as-a-service (SaaS) company. But if you're developing something like a medical device or something in the energy industry, you’ll likely see different key team members in these sectors.
Can I expect a Product Manager to have UI/UX design background? Is it common for one person to be an expert in multiple areas?
Your team will likely be responsible for many roles and responsibilities in the very beginning. When you're in an early-stage company, you're wearing a lot of different hats and could be doing everything from leading strategy to sending calendar invites to helping develop the product.
But as you start growing your team, you'll want specific people for these roles. A really great example is on the software side: you could get someone that might call themselves a full stack engineer, but that would mean that they understand both the back end and the front end, though they might not necessarily be good in both areas. As you start to grow and scale out the business, you'll want to have the right expertise in those certain areas.
While someone might be wearing multiple hats initially, you can’t expect them to be good at everything. Of course, there could be exceptions—maybe this person has been very successful early in their career, or they’re a multiple-time founder.
Because founders often try to run a lean team and are sometimes raising a round in order to bring team members on, what stage would you expect the A team for a startup?
As you’re trying to run a lean team in the beginning because you’ve likely bootstrapped, it depends on the type of company and product you're building and the experience and expertise of the founders.
For example, when building technical products, having someone that actually knows how to build and scale software is critical. Otherwise, what could end up happening if you have someone who is only okay at building the product is you're going to run into a lot of technical debt.
Once you start to get more transactions, add in payments, and layer on other requirements, it can be mismatched together and requires you to hire or bring on more expensive resources to redo and rebuild everything.
Is ESG a material issue?
Short answer—yes. We are seeing many funds starting to invest based on ESG and impact. The Telus Pollinator Fund is a great example of that.
How does economies of scale differ from the network effect?
Economies of scale has more to do with the company itself and what they can do, whereas network effect is a lot more about the user base—that the users will increase the value of it.
Which is a better story: a 50% chance of 10x or a 5% chance of 100x?
A 5% chance of 100x almost every time because people want to know you're thinking huge. Obviously, you're going to have to be able to back it up, but ideally, you want people who have that kind of vision and a line of sight toward achieving it.
As an investor, is it more appealing when a founder knows their ideal exit? Do I need to know if I want to go IPO vs acquisition vs viable profit?
The big thing that investors are always thinking about is the exit or transaction date.
Sometimes, you don't actually have to know the answer because the investor might have that in mind. Investors could have certain larger corporations that they work with with the thought, “This could be a great acquisition for that company,” or “This would be great for an IPO.”
It's good for you to have a potential understanding of where it could go in the long term, but you don't have to have it fully fleshed out. Understanding the different scenarios is important, but you don't have to know how you’re going to exit or what's going to happen. A lot of the time, that’s specifically an investor or VC’s job to know and think about that.
From an investor's perspective, you want to know that the founder is at least thinking about their exit because it demonstrates alignment between the founder and investor. If the founder thinks this is going to be their company for life, then they're not understanding the fact that people need to be able to get their money out somehow.
As mentioned, founders probably won't know if it will be via IPO or merger acquisition since that's way out into the future, but you want to have a sense of them knowing who they could potentially sell to. And ideally at some point, they're bringing those people on board, whether as strategic investors, partners, or something along those lines.
Understanding the goal to earn 10x ROI after 10 years, how do you deal with a big number or investors that are asking for returns before the long term?
You want to be aligned with your investors. If an investor is expecting something a lot earlier, or if they're saying, “We're in this, and we support you, but we want an exit within 5 years,” oftentimes, that's not going to be ideal and it's not realistic.
Keep in mind power dynamics. It can be hard when you're going out and raising and you need the capital, but ultimately, this is a long-term relationship. So if someone's already misaligned with you on that fact, they're probably not going to be a good partner. They're probably going to be pushing you to make decisions that are not in the best interest of the company, so they're probably not your people.
Would convertible notes or SAFEs be investment tools you would stay away from? In my experience, these are short-term financing tools.
Simple Agreement for Future Equity (SAFE) or convertible note are fundraising instruments typically used in the early stages of raising outside capital, primarily at the Pre-Seed and Seed stages. Among their most attractive attributes are their simplicity, flexibility, and ability to defer valuation until what's known as a "priced round" (typically a Series A financing), at which point a lead investor will set a valuation on the startup company.
In other words, SAFEs and convertible notes are not intended to be long-term financing solutions on their own. Instead, they serve as bridges to future equity financing rounds. Most startup founders use SAFEs and convertible notes because of their ease of use and founder-friendly terms and therefore do not shy away from using them.
Looking to learn more about early-stage investing? Take a peek at a couple of our recommended reads to learn more:
And for more in-depth, immersive learning, registration for the Fall Cohort of our Financial Feminism Investing Lab (FFIL) is open!
Run in collaboration with the Haskayne School of Business, University of Calgary, FFIL introduces participants to the ins and outs of early-stage investing and teaches aspiring investors how their dollars can power the next generation of future-fit, feminist businesses.
*Please note that the information provided in this blog is for informational purposes only and should not be construed as investment or financial advice.
