The 3 M's Angel Investors Consider Before Investing
As an investor (whether angel, VC, or seed) 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. Carlos Eduardo (not the European soccer player) is the co-manager and partner of Seedcamp (a leading micro-seed investment fund in Europe) — he claims that: “A startup’s management team is its lifeblood… no amount of awesome ideas will ever overcome a fundamentally flawed management team.” (Source)
Still not convinced?
Why do startups with great ideas fail?
According to research from the University of Tennessee, while almost all startup failure is due to some sort of mismanagement, 30% of all startup failures can be directly attributed to what it describes as Unbalanced Experience or Lack of Managerial Experience.
The thought process is that while someone who is new to the game may have a learning curve, the savvy vet will be able to steer clear of many of these common pitfalls.
Why should I care?
According to an article published back in the Wall Street Journal, 30% to 40% of high potential U.S. startups fail — with failure being defined as the need to liquidate assets.
This fact isn’t really all that surprising: startups are known to be risky. However later in the article, the author mentions that a massive 95% of startup investments fail to meet projected ROI levels.
You’re probably asking yourself right now… If, at best, I am a one in twenty shot of hitting it big with a startup, there are certainly a bunch of casino games with better odds?
Yet, despite the odds, more people are getting interested in early stage funding — just check out the excitement around Kickstarter and Indiegogo.
In fact, in an article featured on Techcrunch Robert Wiltbank noted that although, in any single investment angels are still <50% likely to make money, diversified angel portfolios (at least 6 investments) are making 2.5x returns on average over a 4 year span.
So now for the million dollar question: 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 do I increase my odds of investing in that 5%?
2 Approaches to Identify Successful Teams
Mainstream Classic Approach
These 5 traits have been highly touted, most of them for at least a decade, and still are preached 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, the 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 took them from a $12B valuation to a $505B valuation during his tenure) mentioned this trait as critical in his hiring decisions. Micromanagers who are overly involved, and to borrow a term from Mark Suster, 'skip', are not conducive to a positive work environment.
- Embrace change: Steve Blank, a serial entrepreneur, put it best when he said, “Startups are inherently chaos… 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) believes 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.
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.
- 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.
- 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?