Part II: Evaluating: 2nd Fundamental of Early-Stage Investing
Evaluating early-stage startups is about assessing the context in which the start-up operates. In other words, every evaluation should be done using a nuanced approach due to the unique challenges and opportunities in the assessment environment. Looking at it from this angle helps me consider the evaluation concept from an African perspective because Africa has its peculiarities.
However, this post is an overview of Part II: Evaluating: 2nd Fundamental of Early-Stage Investing, from the book, “Winning Angels, The Seven Fundamentals of Early-Stage Investing.”
This second fundamental focuses on evaluating early-stage startups to help investors understand how to access an investing opportunity so that they can find the best possible deals available while appraising the possibility of investment ideas. The text expands the Harvard Framework- an evaluation technique angel investors use to assess possible investments. The framework shows the potential of having hands-on experience when identifying suitable investment deals. The proposition of an enhanced framework helps with providing a more thorough evaluation technique.
People, opportunity, context, risk, and transaction structure are the five fundamental pillars of the Harvard Framework. Each element is reviewed to comprehend its significance in investment decision-making.
People refer to the entrepreneurs and management team, highlighting that the expertise and dedication of these core people are critical to the success of any intending startup. Hence a thorough review of them is vital based on their goals, knowledge, and capabilities. An angel investor must examine the start-up’s founding team and powers, ensuring diversity and a mix of relevant skills and experiences while not leaving out the passion, commitment, and understanding of the start-up’s market. Efosa Ojomo in his article refers to this concept as ‘love’, “love of people, especially people who haven’t had access to the product the market creator is introducing; love of your product and what it can accomplish; and love of the process that will bring the product—and the market—into being.”
Evaluating the market potential, competitive advantage, and scalability of a business idea is what opportunity entails. Considering a business idea’s market potential, competitive advantage, and scalability is also a considerable part of the investment opportunity, which includes looking out for the market attractiveness and asking questions like, does the product or service of the startup company have a vast and rising market? Is the product or service of the startup revolutionary or evolutionary? Is the company’s product or service unique or has a durable competitive advantage?
Context considers external factors such as market trends, laws, and the company environment.
This aspect helped me view context broadly to mean understanding the local context in which the start-up operates, which may include cultural nuances, political stability, socio-economic trends, and legal frameworks that can significantly impact the start-up’s success. For instance, angel investing is a recently growing concept in Africa because many investors are still finding it challenging to understand Africa’s market dynamics and how presented products and/or services will be able to solve or navigate existing local challenges.
Almost everything in business has some risk, and so does angel investing. As noted by the author, angel investing is a high-risk venture with a considerable potential of losing money on investments. At the same time, returns on investment can also be relatively high if one gets it right, hence the need for risk assessment.
Risk assessment includes understanding the hazards associated with the investment, such as market risks, execution risks, and financial risks. Here, the necessity of risk management in early-stage investing is stressed, explaining different risk scenarios and offering risk-mitigation solutions. Bets must be reduced to increase the likelihood of success as an angel investor. As a result, angel investors should consider diversifying their holdings, conduct thorough due diligence, and actively support the companies they have invested in.
Understanding the start-up’s business model is also critical when assessing its business plan and determining whether it is viable in its operating market. Understanding every aspect, including income sources, cost structure, customer acquisition strategy, distribution networks, and scalability, should all be considered. Angel investors need to look for firms with sustainable, innovative, and market-specific business models that will allow for growth and success.
The place of technology is critical during evaluation to determine the level of differentiation and innovation that the start-up is bringing into the market of operation. For example, rural African communities face challenges that need solutions. Not just any solution but solutions that will disrupt what already exists will immensely benefit an angel investor to evaluate the scalability technology may bring and the competitive advantage it may provide before investing.
Furthermore, the expanded framework includes additional criteria to evaluate throughout the review process. These criteria include determining the connection between the entrepreneur’s and investor’s aims, investigating the investment’s social and ethical impact, and analyzing the entrepreneur’s ability to learn and adapt, including additional factors to consider when looking at an asset such as:
- The investment size: How much money is available to invest?
- The company’s current stage: Is the company in the seed, early, or late stages?
- The exit strategy: What plan is laid out to profit from the investment?
When it comes to winning and quick angel techniques, successful angel investors are often those who can:
- Find good deals: This entails locating businesses with promising futures.
- Invest early: Early investment entails gaining a significant portion of the company and entering the market first.
- Support the management team: This entails offering the management team support and direction.
On the other hand, angel investing comes with rejection. To remain motivated, angel investors will encounter many sacrifices, and learning how to handle rejection must be sustained.
Nonetheless, success is the critical motivation for investing. Angel investors must think about those things that can increase their success in landing good investment deals, including harnessing the value of networking with other angel investors (which can be highly beneficial), focusing on areas of expertise, leveraging existing knowledge and network to make informed investment decisions quickly, continuous engagement in lifelong learning, and patience when making investments.
Ultimately, the evaluation aims to give the angel investor a comprehensive framework and methods for assessing investment prospects, controlling risk, increasing the likelihood that the early-stage investments will succeed, and increasing the angel investor’s engagement with local investors, incubators, accelerators, and angel investor communities that can provide valuable insights and help mitigate the challenges of evaluating early-stage start-ups.
Resource
- Amis David, Stevenson Howard. 2001, “Winning Angels The 7 Fundamentals of Early-Stage Investing”, Pearson Education: 2001
- Efosa Ojomo- “3 Traits of Successful Market-Creating Entrepreneurs, creating a market isn’t for the faint of heart. But a dose of humility can go a long way” – Extracted June 10th 2023 at 11.55pm
Hi Dolapo, I was drawn to the explanation of the People section in your post. You mention that conducting a thorough review is vital, especially the passion, commitment, and understanding the market components. You add the article that talks about the love of people, product, process. My assumption is that a founder’s business model should reflect the love of the three components mentioned above. And as the book describes, if a founder is an “A-Quality” person running a “B-quality” company, then they have the characteristics that will yield more success to both, the investor and the founder and team, than if the company was innovative but was run by corrupt people. Conducting a timely Evaluation is key to identifying what you, as an angel investor wants, and what to watch out for so not miss any red flags.
Hi Valentina,
I absolutely agree with your add on comments. Thank you for that beautiful summation.
Dolapo
Dolapo,
Thank you for taking the Harvard Framework, from our reading, and applying such a comprehensive lens to it.
Like Valentina, I was particularly drawn to your section on “People,” namely this part: “An angel investor must examine the start-up’s founding team and powers, ensuring diversity and a mix of relevant skills and experiences while not leaving out the passion, commitment, and understanding of the start-up’s market.” Yes. There is SO much value in having a diverse, passionate team!
I deeply appreciate the quote from Efosa Ojomo, which pulls the whole section together. “… love of people, especially people who haven’t had access to the product the market creator is introducing; love of your product and what it can accomplish; and love of the process that will bring the product—and the market—into being.”
I, for one, am feeling very inspired. Yes, profits (or predicted profits) can carry a lot of weight for investors, but people are the power behind it all.
-Amanda
Hi Dolapo,
Wonderful post! As I read it, I like Valentina and Amanda was drawn to the people aspect as well – diversity being the key component for me.
But, what really kept popping up for me as I read it was “Shark Tank”. Now, I will admit that I have watched it only a few times (about 3) but, what I remember about is the investors wanting to know the numbers…. bottom line. No matter how great the pitch was, it always came down to the numbers and what they looked like over a course of a few years.
Surprisingly, some of the businesses that come on and are offered the opportunity to have one of the investors partner up with them, for large sums of money at times say “No”. Why? Because they know they know their worth and they are very familiar with the inner workings of their company. Many of those who have said “no” have gone on to become very successful in their businesses. At times bringing in more money than the partnership with the investor would have done and not having to split the profits with them.
I believe that securing investors for some is a great idea but for others maybe not so much.
I think that as we talk about Angel investors evaluating a business, we as business owners need to do the same when it comes to the investors. I liken it to applying for a job and going for that interview. It is not only an opportunity for them to see if I am a good fit, but also an opportunity to see if they are a good fit for me and my business.
Great post!
Ase’
Sala