How to choose a winning startup (Hint: Start with the founders)

The 3 M's angel investors consider before investing

As an investor (whether angel, seed, or VC,) arguably the most essential element in identifying a promising investment is the management team. This idea led to the famous mantra that just like in real estate there are 3 L's – Location, Location, Location; in the startup investing world there are 3 M’s – management, management, management.

In fact, many VCs prioritize talented, creative, and experienced management over a great idea, product, or booming sector. David Peterson, a partner at Angular Ventures remarked, “A VC should be about believing in something before everyone else. The type of investing I’m drawn to is one in which there is a deep committed partnership, with trust flowing in both directions.”

Why do startups with great ideas fail?

According to the US Bureau of Labor Statistics, some 20 percent of all businesses fail within their first year of operation. In a post-pandemic age, when US state governments forced the shuttering of approximately 30 percent of businesses, the years 2020-2021 were a time when people, needing to generate income - started their own businesses. In the startup world, about three out of every four ventures fail within the first 12 months. In a recent survey, more than a third of respondents said that “running out of money” was the top reason for a startup’s failure. One conclusion that could reasonably be drawn from this is that inexperienced owners or management teams make a series of poor decisions that more seasoned founders would perhaps avoid.

Startups are known to be risky. Indeed, some 95 percent of startup investments fail to meet projected ROI levels.

Despite the odds – and some might think that there are better odds playing in a casino – an increasing number of people are getting interested in early stage funding, although the economic uncertainty can check this movement..

If a good startup team is an integral part of a successful business, what guidelines can an investor use to recognize early stage potential? How can they increase their odds of investing in the five percent or so that do become successful?

Two approaches to identifying successful teams

Mainstream classic approach

These five traits – most of which have been around for more than a decade, are still highly prized today as best practices:

Experience: An experienced combination of founders, executives, and staff. Nothing speaks like a team with a proven track record launching in a new direction. Georges Doriot (a famous Venture Capitalist who dropped out of Harvard Business School only later to become a wildly popular professor) apparently was fond of the saying “always better to back an A-team with a B-plan than an A-plan with a B-team.” Doriot, along with most others, invested in people over ideas.

Business acumen: Sean Wise, a previous head of Ernst & Young Venture Capital Canada division, coined the term over a decade ago: “The Talent Triangle.” The first 'element,' as he called it, was Business Acumen. Wise argued that relevant experience, at the executive level, was most important. This distinction leads to the logical conclusion that someone with loads of executive managerial experience, let’s say a CEO at a Fortune 500 apparel company for 30 years, might not be a good fit for a biotech startup in need of angel investments.

Leaders not managers: Leaders create, managers mitigate. Jack Welch (former CEO of GE elevated them from a $12B valuation to $505B during his tenure) mentioned this trait as critical in his hiring decisions. Micromanagers who are overly involved are not conducive to a positive work environment. Another way of looking at the issue of leadership is a quote from the former Chief Rabbi of Great Britain, the late Lord Jonathan Sacks, who wrote that “Good leaders create followers; great leaders create leaders.”

Embrace change: Steve Blank, a serial entrepreneur, put it best when he said, “Startups are inherently chaotic… This means the brilliant idea you started with will change as you iterate and pivot your business model until you find product/market fit.” Without an adaptable and dynamic core, rigid leadership only increases the likelihood that a startup will result in just another addition to the long list of startup failures.

Small group of founders: Naval Ravikant (founder of AngelList) assesses that ideally two or three founders with different talents is best for a startup. Fred Wilson also noted in his experience that 2-3 founders seemed to be a common denominator among successful startups. Individuals have different skill sets and expertise to bring to the table. While having different opinions is often beneficial, too many opinions will only stunt growth and prevent a dynamic startup from moving forward. It is having the right, cohesive, small combination of people that is important.

Contrarian views 

These views have also been around for at least a decade but downplay the importance of an experienced team and have remained the minority view in that they are not generally the way big VCs think.

  1. Dedicated workaholics: High level executives with years of experience are worth the money, just not early on when most startups either don’t have capital or are pinching pennies (if they did have capital they wouldn’t be asking for your investment). In such cases, allocating a significant portion of funds on “experience” is not ideal. What you need in a successful team are motivated workaholics who will put in hundred hour weeks.
  2. You won’t get experience! Tom Perkins admits he is in the minority, but subscribes to the notion that a good idea > management team. “Why would anyone good join a high-risk startup?” he asked. “Remember, this is early stage stuff. What you need to do is develop the idea, get the risk out up front, then roll the money in and develop the company.”

How important is experience to you? What other factors do you believe contribute to good startup management?

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