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What do we look for when investing in a startup?

June 8, 2022
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Published by Vassil Terziev, Managing Partner at Eleven. 

What do investors look for when investing in a startup? The quick answer is that each VC has its own approach – there are similarities and there are differences. In any case, a key thing to remember is that when you pitch, you are selling. And to sell effectively you need to understand how the world of the other side works and how investors think. We thought we would make it a bit easier for the companies thinking about working with Eleven to know what matters for us.

Whenever we evaluate an investment opportunity, first we want to see positive signs in the intersection of three aspects – the market, the team, and our contribution as an investor. This is the case assuming that we’ve already covered ground zero as per our investment thesis, namely a pre-seed startup with its roots coming from Southeast Europe which builds a tech product in any of our five priority verticals – Fintech, Healthcare, Future of Work, Future of Food and Ecomtech.

In the next paragraphs, we will take a look at each one of the three aspects individually and find out why their intersection is important.

First, is the market – because market beats everything.

A good team in a bad market is a bad to mediocre outcome, while a mediocre team in a good market is a good outcome. There are three main aspects within the market, which play a very important role in our investment thesis. The first aspect is the size – how big the market is or how big it is likely to grow. The bigger the market, the more exciting the race is for the founders and for us. The bigger the company could get and the more value it could bring to customers and the ecosystem it grew in.

On the side, for investors unicorns are not just a vanity target, it is really about how the math works. In our case, it is a EUR 60 million fund and if we aim to create a 5x gross return, assuming a 10% average stake in a company, that means to create 3 billion euros worth of outcomes in the next 10 years. From zero to 3 billion in ten years or less. This is why for the math to work out, we need one or two companies to be breakout winners and we cannot do that in a small market. 

The second aspect within the market, which is important to us, is maturity – because timing in a market is equally important. It might be a big market but it might be captured and not available for disruption. So what we are looking for is tectonic shifts – when there is a big disruption of a value chain or when there is a development of an entirely new one. This is where real impact is made. We didn’t have a value chain for space travel or colonizing Mars but in 20 years we will. So it is really about whether it is a big disruption in a big existing market or the creation of an entirely new one. 

The third aspect is what it takes to win. Because based on whether you are an early mover or not dictates different strategies and the possibility of different outcomes. We are trying to understand where we are in the cycle of that market and what type of strategy the company needs to employ to win – is it going to undercut the prices, is it going to win with innovation, etc. The different setup dictates different strategies. 

Moving on with the second concentric circle – the team.

The first aspect within the team to which we pay special attention is team dynamics. You can argue that even a single founder with exceptional skills can build great companies but more often than not it is a team effort. And the more people appreciate each other, trust each other, and have learned to make the best decision in a complex environment, the better the outcome. Also, the more balanced the team is in terms of multiple strong people coming with different functional knowledge, the better the outcome. Have they worked together before or not? Did they just assemble a team because they are seeing some short-term opportunity or because they are in it for the long-term and have experience together? The more the team is committed and the stronger it is in terms of prior work experience, domain expertise, and functional capacity from day one, the bigger the chances of success. 

Then we are digging deeper into the personal traits of the founders like honesty, discipline, resilience, how hard working they are and the most important – their integrity. You might be a master of growth and produce astonishing results with your startup, but if you are missing the right values and principles to govern your thinking and actions, this success will be short-lived and not sustainable. We also look at how coachable the founders are, because if they are not, we cannot help. Ultimately, a VC can help only as much as the founders permit them to. We can recommend, we can highlight the problems, but we can’t do the work, we are not the founders of the company. The value we bring is irrelevant if the other side doesn’t want to use it.

The last aspect is team ambition – why does that team want to solve that specific problem, what brought them to this? Is it a personal story? Is it a work experience? Where would they like to take the company and what would they like to achieve? The stronger the ambition of the founders, the more resilient they are. Every startup faces a lot of challenges, so resilience is one of the characteristics that we want to see in founders. There’s a strong correlation between the commitment to the mission and the ability of the team to go through pain and suffering to deliver a positive outcome. 

The last concentric circle is about our contribution as investors and partners.

What kind of work do we have to do to fill out the missing bits? Can we do something about the big white spots? Do we have enough of a network? Do we know enough about the domain? Can we help with hiring? 

The important question we ask here is can we buy enough of a runway to prove the key hypotheses about the market opportunity so that we are ready to pass the baton to the next investor. And to be more specific – if we assume that the most natural follow-on investor for us is a seed investor, what we try to look for is how much time and effort would it take to get to product-market fit and have a business model that holds. Then with the seed investor, it is about proving that the model actually works. And then with the series A and beyond investors, it is simply putting more fuel into the fire and all about how fast the startup can grow its team to expand the machine. The more prepared you are, the easier it is to grow. 

The sweet spot for us (and most probably every investor) is to have a full-fledged team with people who know what they are doing where we just help accelerate the momentum – focusing more on the business development and strategic side of things. So that we are not part of the building but we just try to provide further air cover for them. However, this rarely happens. Even with very experienced founders, there is a lot of discovery work and a lot of effort to get to product-market fit and take off. But after all, that is what makes our work so exciting. 

Being positive about the three points mentioned above in a certain deal does not guarantee that we will actually proceed with the investment. While these three aspects have key importance in our decision-making, they are part of an array of factors which we consider during our due diligence. More on these in an upcoming article.

If you are currently fundraising and you think that we might be a good fit, get in touch with us and let’s talk. 

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