What Investors Consider Before Investing in Startups: Part 1

Startup founders and other entrepreneurs frequently ask me what investors consider a company before they invest. While different investors might have a different approach, you can be sure that they have a process they follow to determine what’s a good fit for them. I’ve outlined in part 1 of my exploration some of the key factors I consider before writing a check to a new company.

All entrepreneurs must understand what investors consider before investing in startups. Whether you’re just starting on your startup journey or actively looking for VC funding right now, knowing what prospective investors want will make your life significantly easier. Every successful startup had investors along the way. Facebook, Uber, Airbnb, and others all had to pitch investors to grow their businesses and achieve worldwide success. As a startup entrepreneur, you’ll eventually have to as well!

In this two-part series, we’ll explore everything that investors will consider before cutting your business a check. For this first part, let’s explore seven aspects of your company at which investors will take a look!

Table of Contents:

  1. Your Pitch Deck
  2. One-Pager
  3. Recommendations from Other Investors
  4. Due Diligence
  5. Past Funding
  6. The Team
  7. The CEO
  8. Conclusion

Your Pitch Deck

Your pitch deck has to be good. More than that, it needs to be so good that it will pique the interest of investors that have heard it all before. Consider how many business pitches investors get every day, week, and year. It’s quite significant as there are always startups out there that are looking for funds.

One way that startups differentiate themselves from each other is through the pitch deck. Investors become skilled at assessing people’s pitch decks. They know all the red flags (like lots of show with little substance), and they also know a solid pitch when they see it. In short, they can detect when someone’s bluffing as compared to a business owner who is pitching a legitimately positive investment opportunity.

You know that the opportunity that you’re presenting is a positive one. However, without the right pitch deck, they won’t understand that.

As a startup, you should spend quite a bit of time perfecting your pitch deck and your pitch. The pitch deck should be clean, concise, and to the point. You should explain your product, mission, team, and critical metrics. Your goal shouldn’t be to detail every nuance, but rather to provide prospective investors with a high-level overview of your business. You want to excite them about the prospect of partnering with you! If they need to see any details (like why you’re forecasting that you’ll have a below-market churn rate), you can explain it verbally as part of the pitch, or you can provide them with evidence later.

When pondering what investors consider before investing in startups, you should know that the pitch deck ranks incredibly high. Therefore, please make sure you spend time perfecting it and soliciting as much feedback as possible.

One-Pager

Your startup’s one-pager is an executive summary of your project and how you’re planning to thrive as a company. Most investors will review your one-pager. While it may not have quite the same weight as your pitch deck, it’s certainly something that they’ll consider.

Your one-pager should act as a brochure about your business. It should summarize the startup, including some brief statements on your mission, history, location, and why investors should look into your business more. Think of these one-pagers are something that investors will review in their off time and might even share with other interested parties.

With your one-pager, you should think of it as a complement to your pitch deck. Your site or document should highlight many of the same essential points, but not be a duplicate. Make sure you include members of your team so that investors can become more familiar with your startup.

Recommendations From Other Experts

If you have recommendations from other investors, these recommendations are what investors consider before investing in startups. These are incredibly important as a positive recommendation makes other investors more likely to put money into you and your team. Conversely, a negative review will put off prospective investors.

If you already have investors in your project, you should ask them for recommendations and endorsements to encourage future investors to join. However, these investors have a vested interest in helping the next people to join. The most potent reviews are ones that are not involved in the current project but were a part of previous endeavors of yours. These investors are impartial and have no vested interest in encouraging others to join this current venture.

The best recommendations are instances where they made their money back. However, you don’t necessarily need to have returned the previous investor’s money for it to be a positive recommendation. A failed startup can still elicit a positive review from a prior investor if it failed graciously. Investors understand extenuating circumstances, a professional demeanor, a challenging project, and other similar situations. If your startup failed because of these types of challenges, your previous investor might still recommend you.

Make sure to highlight any recommendations. There’s nothing more soothing to an investor’s ears to hear of a previous experience where you either had a successful exit or tried your best to return as much of their money as possible.

Due Diligence

Every investor will do their due diligence before cutting a check. This due diligence is usually quite extensive. As the levels of investment increase in the later funding rounds, the due diligence grows as well. When pondering what investors consider before investing in startups, it’s essential to be aware that an angel investor might request some necessary documents and a copy of your books before cutting a check. However, in the later stages, when potentially many millions of dollars are at stake, the due diligence becomes significant.

To get an idea of what investors might ask for, here’s a list. Please note that the following documents are by no means exhaustive.

  • Vital company documents, like articles of incorporation, shareholder minutes, and officers
  • Securities information, like a record of shareholders, your capitalization tables, and other agreements related to shares
  • Debt documents, like how much your business has borrowed, and when you’ll need to pay those debts
  • Contracts, such as those of significant clients, or distributors
  • Legal documents, like records of lawsuits, liabilities, government investigations, or employment claims
  • Information related to real property or intellectual property
  • Financial statements, including your balance sheet, cash flow statement, and income statement
  • Information on your R&D, including any proprietary technology your business might have
  • Information on employees, benefits, and agreements you have with crucial talent
  • Equipment your company owns and financial data related to it

This list is by no means exhaustive, and not all of it will apply to your startup. However, you should know that due diligence can be quite thorough, so you should have appropriate staff members prepared to spend quite a bit of time answering any prospective investor questions.

Past Funding

Another factor that investors consider before investing in your startups is if your startup has already received funding in the past, prospective investors will undoubtedly consider it. If your capitalization table is already too large, that could dissuade a potential investor from joining.

As an example, suppose that you have two businesses. Business A has one angel investor that has taken 10% of the company. You’re debating becoming the second investor seeking another 10%.

By contrast, let’s assume Business B has ten investors, all from the angel investment stage. The first investor took 10%, but that position became diluted when the second investor joined. The third investor diluted the second, and so on. You’re now position 11.

The first company, Business A, is undoubtedly a better investment. The fact that the second company has so much dilution makes your investment incredibly risky. It would be one thing if Business B had that many investors but had advanced to Series A and B funding rounds. However, given that they’re still at the angel level, there’s a good chance that even if you did invest, they would dilute your position.

There’s another aspect of past funding that investors will consider: from where it came. If you had a couple of angel investors, a couple of VC firms, and are now looking for Series A funding, that’s a good sign! It means that your business is growing. But, if you had done all four rounds at the angel investment level and are seeking to have yet another angel investor, that doesn’t bode well.

Investors look for funding progress that makes sense.

The Team

Many investors invest more in the team than they do the business or idea itself. At first, this might sound counterintuitive. After all, a quality business plan, sharp product, and fantastic talent are what most startups look for to launch.

An investor’s point of view is different. They are looking for a diverse team that can solve any set of challenges that come their way. They’re looking for a group of people that work well together and come up with stellar ideas. If you give that team a business, no matter what it might be, they’ll find a way to come together for its greater good. The right group has the chemistry to persevere during tough times.

Therefore, when it comes time to cut a check, most investors think about the team. They want to hand their money to a group of individuals that inspire confidence. You can have the best business plan in the world, complete with the best product, but if your team doesn’t have the chemistry, talent, or socialization necessary to get it out to the market, there’s very little chance that your business will survive. Investors know this, which is why they only invest in companies that have incredible talent and chemistry!

The CEO

If the CEO (which is likely you, the founder) and the investor don’t get along, there will be fights, so it is unlikely investing in your startup would go well. That fighting might be detrimental to the business’ success and jeopardize the investment. Therefore, any investor will spend some time with the CEO to ensure that they can get along and work together.

Additionally, investors will evaluate the CEO on other levels too. They’ll want to ensure that the CEO is someone of excellent moral character and that they will treat their money with respect. All too often, CEOs let having money go to their heads, and the result is often not pretty. Most investors will also evaluate a CEO’s responsiveness and communication style.

They’ll also look at the personality of the CEO. Is the CEO someone who’s always seeking to learn, grow, and find feedback? Do they demonstrate high independence and leadership skills? Remember that investors have seen it all before. They’ve witnessed which CEO types fail and which succeed. They’ll undoubtedly want to ensure that your startup’s CEO falls in the latter category!

The CEO is most certainly one of the most substantial aspects of what investors consider before investing in startups. Without a quality CEO at the helm, an investor will quickly lose confidence in the venture succeeding.

Conclusion

As you can see in part 1 of my exploration of what investors usually consider when deciding to invest or not that investors consider many aspects of the business as part of the process

Investors will analyze and scrutinize every aspect of your business before cutting a check. Even though it may feel a little overwhelming at times (especially if this is your first company and first-time seeking funding), know that it comes from a reasonable place. The investor wants to ensure that they will make a profit off this endeavor. They can’t do that without a solid pitch deck and one-pager telling them what your company is about and why you’re unique. They can’t do that without meeting the team and spending time with the CEO to ensure everyone is passionate about the business.

Investors do extensive, meticulous due diligence to ensure that everything you’re saying matches your presentations. They delve into your previous funding rounds and seek recommendations from other investors because it gives them insight into your history, business acumen, and demeanor.

These seven aspects of what investors consider before investing in startups are by no means an exhaustive list. There will be a follow-up post detailing another seven things that investors look into before cutting the check.

However, as a startup, please know that whether you’re asking an individual or company for $50,000 or $5,000,000, put yourself in the shoes of the investor before making the pitch. Using these items as a guide, think about how you can make that person feel comfortable, confident, and energized to say, “yes, let me be a part of your team!” Once you have that figured out, you’ll unlock many funding opportunities!

 

About the Author

Jonathan Hung is a transformative Los Angeles angel investor and venture capital partner who believes in a bright future for businesses seeking to broaden their horizons in North America and Asia. One of the most active angel investors in Southern California, his mission is to drive value creation within each portfolio company. In support of this mission, he serves as Co-Managing Partner at – Unicorn Venture Partners – providing a hands-on approach to supporting companies by offering strategic expertise in operations management, finance, business development, multinational business strategy, entrepreneurship, networking, data analysis, and leadership.

Jonathan believes that every start-up/portfolio company regardless of industry and size can take full advantage of his genuine approach to mentorship. Jonathan specializes in early-stage investing and the formation of strategic business partnerships. He invites connections with any professional who shares his passion for the technology and consumer market sector, entrepreneurship, and venture capital.