Everyone makes bad investments once in a while. Sometimes you might ask yourself, how did we get into this situation, and boy I wish I’d done something different in hindsight. I now get asked a lot what I think a dealbreaker is for a venture investment. While there are a lot of metrics and commercial based aspects you can look at (see David Skok here or Brian Balfour here) there is also a lot of belief in the team, industry and opportunity.

Some simple “gut” questions I ask myself about a company before investing.

• If I wasn’t an investor would I work at this company?
  • If the problem isn’t painful for me, I could be a good investor in it, but to be a great one it should be something that I / my team can identify with personally and see where we can add personal value
• Do I feel like if I was going to lose all my money that I would question if the team would have done everything not to go out of business
  • Great founders are constantly evolving, they are always tampering, optimising and looking forward. If the business fails, it won’t be for lack of trying – if you have any doubt about this you shouldn’t back this team
• Would I invite the founder(s) to dinner with my family / friend(s)
  • This is a more qualitative one and the reverse of a job interview question. Many people will take a job which is a good opportunity and not worry about whether they like their co-workers. As an investor, you will be spending potentially 5-8 years of your life talking to the founders (and neither party can quit easily!). I’ve found it makes a lot more sense if you genuinely like each other.

A simple mental idea that I like to use when evaluating a company is what I call my “four quarters” rule. I find that this aids me to think about whether an investment is reasonable or not and is a good litmus test as part of a larger diligence strategy. Broadly there are four elements based on the quarter percentages adding up to 100%

25%: You should be confident the investment has a 25% or less chance that it will run out of cash without achieving its product aims or getting enough data to prove up an alternate model

What do I mean by that? There are risks in any investment but they shouldn’t put you in fundamental fear you won’t last the year. The investment should have reasonable runway i.e at least 12-18 months, have a reasonable problem to solve and enough chance to rejig / pivot if things don’t go as planned. You should be confident that management are spending enough time assessing whether things are working and have a defined strategy i.e if this hasn’t worked by X date we will need to reassess this model and make key strategic decisions about whether this is a viable solution in its current form. Implicit in this is the commercial market in which it operates and the pace of change in the area which need to be diligenced heavily and separately. A lot of startups are unprofitable, but nothing is harder to fund than something that hasn’t met its targets and hasn’t gotten at least 3-6 months data to prove that an alternate strategy is possible.

50% / 75%: You should be at least 50% confident the investment can achieve 75% of the current financial year forecast (or the next 12 months depending on how much is left in the current financial year)

Look at the vendor presentation / base case forecast. You should hopefully have, as a result of diligence investigations and spending time with the management team and customers at least better-than-not confidence that it can achieve 75% of the management plan for the current financial year absent a material adverse change. While this may seem a high level of confidence, the companies we have invested in that have done well have a very granular approach to their 6-12 month pipeline with identified prospects by name, probability weights and action plans on a per customer basis. There are obvious exceptions here but there is a reasonable chance that the company hasn’t planned well, it won’t sell well (and especially for enterprise SaaS). The best companies have laser focus on the next 6-12 months. If the company does not know what its next 6-12 months are, you should probably question the entire forecast.

75% / 50%: You should be materially confident (75% or more) the investment can achieve 50% of the business plan forecast (or the next 24-36 months depending on how much of a forecast period you have)

Again look at the vendor base case forecast. You should have pretty good confidence it can achieve 50% of the total vendor base case in the next 24-36 months (where reasonable). If the vendor base case has 100x growth in Y2 then discard that, obviously. But typically, if achieving 50% of the vendor 24 month target gives you pause, then this may be representative of broader commercial concerns you have about the business and require further rethinking of your thesis.

100%: Is the addressable market / use case you see at least 100% of what the company says it can be used for

We run a specific strategy of validation through our existing non-tech portfolio with the goal of adding material value / potential clients and synergies. If you can’t see a use case outside of the one that the company presents or you think it is much less, you may not be the right investor for the company. Investors should be able to show different potential paths and help the company grow in ways in which it could previously not access.

 

Anyway, those are some simple principles to keep in mind. But obviously not a substitute for a diligence process – happy hunting!