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NEFF: What drives an investor to invest in a startup?

March 2, 2018

neff-matthew-viewpoint-2018I have been involved in many startup companies: three of them I formed and 16 that I have invested in, directly or indirectly. My most recent investment is in Hotel Tango Whiskey, the artisan distillery here in Indianapolis. Like any venture capitalist, I will tell you that two-thirds of investments generally fail; it’s the one-third you expect to be blockbusters that will carry the economics.

What is it about a company that makes it “investable”? I would identify three key factors:

Does the company operate in a large and growing market? Market growth floats a lot of boats, and absolves a lot of sins. In a great YouTube video made at Stanford University, Don Valentine, one of the founders of Sequoia Capital, identifies market growth as possibly the key factor to consider. Sequoia invested in Google on this thesis, and as you might guess, did pretty well. First ask yourself: Will people or businesses really buy this stuff? And if so, will the market for this grow and carry me forward?

Does the company have a “sustainable competitive advantage”? You have a great idea; once you launch, what keeps everyone else in the world from jumping on your bandwagon when you prove the market appeal? Intellectual property (e.g. patents, trademarks, trade secrets) is a clear form of a sustainable competitive advantage. There may also be other things like barriers to entry that makes it hard for competitors to catch up. For example, with Hotel Tango Whiskey, in addition to the hurdle of getting licensed to distill spirits and the waiting period for that license, I liked the veteran-owned status of the founder, Travis Barnes who is an Iraq war veteran. That gets him an advantage when dealing with government and military buyers.

Does the company have the leadership to make this happen? What you are looking for is an inspirational leader who knows his or her business and the market, and perhaps most of all, is nimble enough to adjust when things go wrong—because things will undoubtedly go wrong. A good business plan with the wrong leader is a sure fail; a reasonable business plan with a stellar leader can make a go of it.

There are a lot of other variables venture capitalists consider when investing. But if a company can’t answer these three questions in the affirmative, my guess is that it will have a hard time attracting venture funding.

As you prepare your “pitch,” put yourself in the investor’s seat. Is this deal the blockbuster that I’m counting on to drive returns and make my next fund attractive? Or is this a time sink with little upside? Understanding the needs and motivations of investors is critical to building a persuasive case for investment.

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Neff is an Indianapolis entrepreneur, lawyer and investor.

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