Investment Evaluation Guidelines

I have been asked many times for a guideline when it comes to evaluating investments that we (or our Clients) make. People ask why we invested in Company X and not in Company Y, Why are we interested in industry A more than industry B etc.

Well, the simple truth is that we invest to win.

We tend to strip out a lot of soft factors and focus on results.
Did management deliver?
Can they do it again?
A lot of investment decision making is based on an understanding of industry trends, a trusted relationship with players that perform consistently above industry average and some form of defensible proprietary technology that is in demand because it solves a specific pain for a given market segment.

If a company has a specific target market segment in their crosshairs, we know that they have done their homework – when management states that they serve all industries, our alarm bells start ringing.

Following is my personal guideline for what really counts when considering investment in a startup or early stage company.

1) Market potential
2) The Team
3) Results
4) USP

Investment Process

• The success of investment in an early stage company depends on people and their ability to execute on a detailed business plan, therefore a lot of emphasis is placed on the team.
• The structure of the investment is vital and requires creative and often complex terms.
• Pricing is a key factor which needs to be carefully analyzed and negotiated.
• An interesting exit strategy is required in order to maximize a timely return.

Investment Selection

• Management Team: Experienced, in-depth knowledge of business, results oriented.
• Innovative Products/ Proprietory Technology: Highly differentiable, superior, specialized expertise, meets market needs.
• Business Plan/ Milestones: Well thought out business plan including milestones and contingency plans.
• Substantial Investment Position: Ability to obtain a substantial investment position, influence the selection of executive management and the strategic direction of the company.
• Valuation: Negotiate and obtain a fair pricing structure.

Initial Investment Valuation

• Underlying industry assumptions
• Realistic income statement over 3-5 years
• Competition
• Major criteria:
  • Technology value
  • Capital requirements
  • Market potential
  • Capital structure
  • Operational cash flow

Determination of NAV for privately held startup companies

• The original cost: An approximation of the fair market value at the time of the transaction.
• Write off: NAV calculation at cost, less any write-off deeemed necessary if subsequent performance fails to meet business plan forecast.
• Capital increase: NAV calculation in principle based on the capital increase price, less 10% to 29% discount if deemed necessary based on valuation factors.
• Write up: A write up is recognized when a significant event occurs such as increased profitability and achievement of milestones.

Personalities

There are four basic personality types. In order for a company to succeed in today’s global business environment, each of these personality types needs to be integrated into as many teams as possible to provide balance and, in many cases an important competitive edge. The key is having the right tools and mindset in order to accurately identify each trait and then know how to position the various types in the organization so they have the best chance of achieving success and interacting well with their managers and co-workers.

THE LEADER – THE “A” TYPE PERSONALITY

“A” type personalities are the ones that are always “looking for a better way” or building a “better mouse trap”. They have an entrepreneurial streak and don’t mind taking risk in order to receive the rewards that can go along with it.

The “A” personality is usually very independent, direct and to the point. They will probably tell you to “get to the bottom line” or give them the “executive summary” to read. They don’t like routine and often delegate routine chores to someone else.

The “A” Personality enjoys change, and one of their biggest fears is falling into a routine. They are very focused on what they are doing and are almost always relatively insensitive to others that might be around them. If they tell somebody something, or explain it, they’ll say it ONCE and expect that everybody listening understood because they’re ready to move on.

“A” type personalities are often found as business owners, managers, sales people (especially straight commission), or any position requiring a very “direct” person that typically “takes charge” and forges ahead. They are very decisive and persistent in getting what they want and need.

THE SOCIALIZER – “B” TYPE PERSONALITY

The “B” type loves to party, travel and be part of groups, and is often the center of attention. They love excitement and are often impatient and demanding as a result of being a “high energy” type. They love the limelight and the “hype” and often do very well in sales, advertising, marketing, public speaking, party planning, travel and other positions where they can have a “good time” while working.

The “B” personality is as Supportive of others as they are direct in their approach. Most people enjoy being around them or watching or listening to them “perform”. Many radio and TV personalities, actors and high-profile speakers are often “B” personalities. It is very important for the “B” personality to be liked by others and can be easily hurt if they think someone doesn’t care for them. They may take it very personally.

A “B” type believes that the world revolves around them… they can be a bit narcissistic and often think things like: “It’s all about me” “Aren’t I great?” This type often does well in sales as they tend to be very talkative and outgoing with people and are normally quite persuasive.

THE INFORMATION HOUND – “C” TYPE PERSONALITY

If you want to picture a typical “C” type personality, think of your accountant, an engineer or a computer programmer or analyst. The “C” thrives on details, accuracy and takes just about everything seriously. They are usually very neat, dress fashionably and are very calculated and precise in just about everything they do.

The “C” doesn’t like “hype”, rather, they want facts… information from which they can verify the details and make a decision. They are very consistent in everything they do because everything has an order or procedure; thus they can be predictable at times and often very dependable, however, don’t expect them to make a decision when YOU want it, as it will only come after THEY have checked all the facts and are satisfied that everything is correct.

They are deep, thoughtful and usually very sensitive. They enjoy know how and why things are the way they are rather than taking anything at face value. They often make good customer service people and sales people, especially if the product to support or sell is something “technical” or involves numbers. They are loyal and patient and can leave customers with a good feeling that they’re somebody that really cares. However, managers may need to make sure they don’t spend TOO much time with details if the objective or expected outcome doesn’t warrant the investment of their time and expertise.
ALWAYS THERE WHEN YOU NEED THEM

THE “D” TYPE PERSONALITY

The typical “D” personality doesn’t like change, preferring instead, to have a set of guidelines from which to follow and they won’t mind doing the same thing over and over. They are usually more motivated by security and benefits and are likely to get the “gold watch” if the company can provide the security they seek.

“D” types are very supportive of others and are often the type that others turn to when they have a problem. Their compassion level is usually quite high and often seem very happy and content with themselves and life in general. They are usually punctual, and consistent. They add “balance” and support in the workplace and may be the champion of the “under dog”.

OPPOSITES

The highest potential for personality clashes is when opposites are working with each other or one working for another in a business environment.
“A” and “D” personalities are opposite of each other. The “A” likes change, is impatient and a risk-taker. The “D” dislikes changes, is very patient and thinks the “A” is crazy for taking so many risks preferring instead to be very steady and seek the security of knowing what you have and what you can count on.

The “B” and “C” personalities are opposites as well. The “B” loves the glamour and the hype, the “C” insists on knowing if there is any “substance” behind it all. Where the “B” can be messy, the “C” is neat and orderly and doesn’t thing “by the book”. The “B” is Extroverted, the “C” is Introverted.

Opposite personalities can also compliment one another if each tries to understand the other’s perspective. Perhaps this is why opposites often marry and lead a very full life, since each makes up for the other’s weaknesses and each brings important characteristics into the relationship.

However, opposites can be a bad thing too, especially if undetected, and not properly managed in the work environment. We have seen many examples where a client will call us complaining of turnover in the sales department, for example. They need a better way to “assess” sales people because the ones they hire never seem to last long enough.

After assessing their sales staff, we’re sometimes surprised to find that their personalities should be very good for the job they are doing, but when we look into their manager or supervisor, we find that they are being managed by an Opposite Personality who expects them to do things in a way that is incompatible with the sales people’s personality!

An example you’ll see us use often is Oscar Madison and Felix Unger from the TV show, “The Odd Couple”. It isn’t hard to imagine the friendly, outgoing “B” type Oscar being a top sales person. He makes friends and builds relationships wherever he goes and seems to do the work of 2 or 3 other people.

If the neat, precise “C” type Felix is his manager and is always demanding that every blank on every sales report is filled out, neatly and on-time every time, it isn’t surprising to see that this won’t work out for long. Nothing is “wrong” with either person, they just need to have more insight into each other’s personalities and find reasonable middle ground from which to work. However, if the manager is inflexible and demands perfection in everything they do, it isn’t surprising to see a lot of turnover in the people that would work for him, especially if the ideal candidate for the sales job was a “B” personality.

Almost everyone has been in this position at one time or another. Even though two people may have opposite personalities, we also have a factor called “adaptability” in human nature, and when presented with a better understanding of what is needed, especially in understanding other people, many can adapt and the results are often almost immediately positive. I wonder how many issues could be resolved with just a few minutes of thinking and a few seconds of adaptation.

VCs.. arrGH!

Many venture capitalists expect entrepreneurs to go out on a limb for them – climbing high while vigilantly sawing away at a supporting branch.

When Clients ask what exactly is needed for funding, I can provide some very interesting answers based on my 20+ years of experience… Here are some of my personal favorites:

An impeccable board of directors
It may not be the first issue you are faced with but this is one of the really important ones. Your board of directors needs to be comprised of a broad spectrum of very skilled individuals experienced in the industry of your company. The venture capitalist firms all look for a strong board and that means a board that brings in money (read Sales), investors and strategic relationships – all the important things you need as an early stage company.

A winning team
You may have a great idea, but if you don’t have a strong core team, investors aren’t going to be willing to bet on your company. Think of this as an analogy to a horse race. Betting on horse races equates to betting on high-tech. Betting on a race is equivalent to betting on the industry your company is in. Betting on a horse is like betting on your company to succeed and betting on a jockey is what a VC is after. VCs want to bet on winners that have proven their abilities before. The team surrounding the jockey is also key but don’t get too caught up in having everyone on board before chasing funds. You don’t need to have a complete, world-class, all-gaps-filled team. But the founders have to have the credibility to launch the company and attract the world-class talent needed to fill in the gaps. The lone entrepreneur, even with all the passion in the world, is never enough. If you haven’t been able to convince at least one other person to drink the lemonade, investors certainly won’t. One other thing… If the founders do not have skin in the game, don’t expect others to invest their savings. To be convincing, founders need to go out on a limb, risk their personal savings, sell their car or get a second mortgage on their home to indicate that they too have risked all to make this company a success.

A compelling idea
“Every entrepreneur believes his or her idea is compelling. The reality is that very few business plans present ideas that are unique. It is very common for investors to see multiple versions of the same idea over the course of a few months, and
then again after a few years. What makes an idea compelling to an investor is that it reflects a deep understanding of a big problem or opportunity, and offers an elegant solution.”

The market opportunity
You should be targeting a sector that is not already crowded, where there is a significant problem that needs to be solved, or an opportunity that has not been exploited, and where your solution will create substantial value. Contrary to popular belief, it’s not about how big the market is; it’s about how much value you can create.

The technology
VCs ask – What makes your technology so great?
The correct answer is, ‘There are plenty of Customers with plenty of money that want to buy it’.
If you have a technological advantage today, how are you going to sustain that advantage in the future? Patents alone won’t do it. You better have the talent or the partners to assure investors that you will stay ahead of the curve.

Competitive Advantage
Every interesting business has real competition. Competition is not just about direct competitors. It includes alternatives, ‘good enough’ solutions, and the status quo. You need to convince investors that you have advantages that address all these issues, and that you can sustain these advantages over several years.

Financial projections
Your projections demonstrate that you understand the economics of your business. They should tell your story in numbers – what drives your growth, what drives your profit, and how your company will evolve over the next 5 years.

Validation
Is there any evidence that your solution will be purchased by your target Customers? Do you have an advisory board of credible industry experts? Do you have a co-development partner within the industry? Do you have Customers or Beta users to whom investors can speak? Do you already have paying customers? The more credibility and Customer traction you have, the more likely investors are going to be interested.

What I have learned is that a company needs good scores in ALL of the above areas and excellent scores in at least 3 in order to have a reasonable chance to secure funding.