Once you dive into investing you can quickly become buried in a tornado of potential deals – the “Dealnado,” as I call it. The Dealnado is a swirling, twisting mass of co-investors, scammers, screaming founders, substandard deals, shiny objects and little baby unicorns buried somewhere inside the chaos.
To sort through this mess you need a methodology to filter the gold from the dirt. This is my framework for picking the best startups, crafted from 7 years of angel investing (and a decade before that of operational experience and research into people, business and conflict). It’s comprised of 5 simple but critical questions.
#1) Would I start a company with them?
This question forces me to think about the quality of the people as well as the founder dynamics. When I sit across from a team of founders I ask myself “Would I join them?”, “Am I inspired by them?”, “Are these the brilliant, crafty leaders I can follow to glory?”. In this context, I’m not thinking like an investor, or a leader, but rather like a prospective early employee. I try to understand their character, their values, their capabilities, and their passions.
A common mistake we make as investors – particularly investors who’ve previously built companies – is asking “Could I lead this team?” or “Could I be a cofounder?” That’s the wrong approach. As investors we can’t actually lead these teams and we can’t make up for major deficiencies– it’s their business and if captains are weak the whole ship is going to sink.
When I met Melody McCloskey and Dan Levine (founders of Styleseat) in 2010, I was overwhelmed by their vision, talent and character – I couldn’t resist the impulse to work with them and invested within 48 hours. And the AngelList office could have been my home – I loved them so much that I invested in their seed and offered to join them full time (luckily Naval and Nivi were only hiring engineers at the time).
#2) Do I love what they’re doing?
This is a question of your interests – do you really care about the problem they’re solving and love their solution? This is a personal question you need to truthfully answer. Many investors follow a deal because it’s “hot” (i.e. includes famous investors or is highly competitive) or because we get sucked into the hype around a broader trend (“motherf’ing BitCoin is going to disrupt everything”).
Your love for the startup matters not just for mental health but financially as well: you’ll be a better investor if you truly care about a startup. You’ll spend your spare time learning about their space, playing with their product, proactively recruiting talent, and making key introductions – all things that benefit the company and build word-of-mouth about your value as an investor.
We recently led a small pre-seed round in a company called Service that’s doing “on-demand customer service”. Aside from knowing the founder (Michael Schneider) for six years now, his approach to solving the global customer service problem from the consumer demand side just felt brilliant to me. I submitted two customer service issues myself right after our first meeting – both representing about $3000 in goods – and Service solved them in no time. Companies failing to deliver on their promised experience really bugs me, and Service’s ability to smooth that over is something I personally want in my life. And it’s a problem that hits everyone weekly if not daily!
#3) Will I add value?
You’ve got to offer more than just money if you don’t want to be left on the cap-table cutting board in a competitive deal. Do you have contacts, expertise, or industry knowledge that makes your involvement matter to this team? Great deals are competitive and great founders guard their cap tables like precious berthing. Only value-add investors get in and if you’re not bringing something of value you probably have little chance of getting onboard when it comes down to sorting out allocation in a round.
When you do bring value to the entrepreneur in the early days of their company, however, you can directly increase the odds of them winning – and winning big. This doesn’t mean you get to lead the company – it means you help the company scale and get a unique edge. A great example is when James Jerlecki pitched me Mytable earlier this year: I’d been researching the concept of “crowdsourced food production” for two years and had an Evernote notebook titled “Chowtown” with over 30 companies, notes from dozens of interviews and countless hours of research (in fact I once hired my sister to set up shop in my home and conducting pilots). So I was ready to add direct value to Mytable from day zero.
#4) Can they have a major impact?
I meet many companies that fulfill the first three questions – the fourth one narrows them down a lot though. You meet great people with interesting ideas where you can add value and then you realize “Damn, even if they win I don’t think it’s going to be huge.” Of course this is all relative. Your definition of “major impact” and my definition may be different. I think about it in a couple ways:
- Market Size: Are they building a solution that can disrupt a massive market or expand the size of the market (i.e. Lyft and Uber bringing chauffeur service to the masses). In very rare cases, they are even creating an entirely new market.
- Massive Improvement: Is their solution poised to make a huge difference in the lives of consumers or businesses? Quite often I get pitched ideas that are marginal improvements, but truly great companies need to trump existing solutions and deliver a major impact to their users.
Central to this of course is the character and ambition of the founders – are they capable of scaling this company to the highest peaks? Generally when I see founders primarily focused on getting acquired and making money, my interest disappears because it’s clear that they’re playing the short game and not driven by the intense need to impact the world that top founders possess.
When we discovered Honk in May of 2014 (thanks to a text from my buddy Avesta of Coloft), I realized in our first meeting how massive Corey’s company could be. Corey had almost single-handedly created one of the most unique and scalable platforms to solve the global roadside assistance problem. There was no doubt in my mind that he was going to disrupt towing with a solution 100x better than anything AAA or the industry had tried previously.
#5) Is this the right time for this idea?
Last of all is timing. Where are societal, economic, technological and other trends moving and how fast are those shifts happening? Are you in the middle of a technology hype cycle and is it better to wait? Is this social shift going to be bigger over time – or perhaps just a momentary blip? Timing requires a healthy knowledge of history, an insatiable curiosity for the world, and a reflective mind that thinks deeply about where the world is moving. Of course, the landscape of trends that could impact a company is huge. You have to boil each startup down to its essential elements and consider how those elements fare over the next 5 to 10 years.
For example, I’ve worked with Cy Hossain (Founder/CEO of Crowdcast) for almost 18 months as he bootstrapped development of his new webinar platform. Existing B2B webcasting tools are outdated and don’t offer a compelling, interactive experience, however the market’s growth and the way people are adopting live streaming video now (versus just a couple years ago) shows we’re at an inflection point that he’ll be poised to seize.
I also dig into the founders and explore their perspective on the timing. I want to know if they’re deliberately thinking about the network of broader trends that may impact them and how they plan to adapt if this trends play out differently.
Making the final decision
As an individual I need a resounding “Hell Yes!” for each of these questions. If I’m not confident in every single answer then I’ll pass on the deal. If you’re working in a team environment the way we operate at Arena then your grading will change to reflect your partnership. You need to be open to how your colleagues think and feel.
Here’s how we approach it at Arena Ventures:
- Team – both partners have to overwhelmingly agree
- Idea – one partner has to strongly agree
- Value Add – the entire team has to agree that we can add value
- Timing and Impact – one partner needs to believe strongly, but if the other strongly disagrees we won’t do the deal.
Of course, every investor should have their own methodology that matches their unique perspective – mine comes from what I’ve seen over 7 years of investing plus my personal background in art, intelligence, and founding a successful defense company. Other investors will have their own questions and weigh the importance of answers differently than I do. If you’re new to investing, it’s important that you start crafting your own method for sifting through the Dealnado to efficiently find the companies you want to bet on.