VCs share top red and green flags when evaluating start-ups for investment
Few things bother venture capitalists more than a founder who says they have "no competition." This was just one bit of advice shared at the Capital Pathways Conversation at 121 Tech Hub.
The Capital Pathways Conversation series on Thursday night, hosted by the Tennessee Department of Economic and Community Development (TNECD) featured an impressive panel.
Alden Zecha, the Managing Director of SideCar Angels, traveled from Boston, Jay Shaffer, the Market Director for Venture South, and Board Member for Atlanta Technology Angels, traveled from Chattanooga, and John Bruck, a former Angel with Queen City Angels, Founding Partner for Market Square Ventures, and Co-Founder of 121 Tech Hub walked down the stairs of his building space.
teknovation.biz readers are likely knowledgeable about Market Square Ventures (MSV). However, if you’re interested in more background, you can Ask Tom (thanks to Brandon Bruce).
Regarding SideCar Angels, it is an angel group that rides sidecar with top-tier angel groups and VCs to fund early-stage companies. According to Zecha, the fund joins investments, after a lead has already been identified and solidified.
Atlanta Technology Angels (ATA) and VentureSouth are both focused on tech-enabled early stage companies in the Southeast region. ATA invests between $250,000 and $2 million, and Venture South offers sidecar investments of up to $10 million per year. Since 2008, the group has invested $85 million in over 100 Southeastern startups.
Green Flags
The panelists detailed a few key indicators that a company may be ready, equipped, and well-suited for venture financing.
Zecha said for SideCar to sign onto a deal, they need to see a proven, working prototype with a solid business plan.
“About 70 percent of the companies never return any money to us, which means we depend on the other 30 percent to give us a good return on investment,” Zecha explained. “We need a reasonable reason to believe that they will return 50 percent compounded year over year to make up for all those other companies that fail.”
Additionally, Zecha said he’s looking for big winners in small markets, versus small winners in big markets (more on this in the red flag section).
Shaffer shared his outlook when reviewing companies for both ATA and Venture South – “repeatable revenue is a non-negotiable.” It’s one of the first things the firms look at to determine traction for the product or service.
He shared that a big green flag is a founder that’s a sponge. Meaning, they are easily coachable. The opposite of a sponge is a brick (more on this in the red flag section).
Bruck weighed in for MSV. He said one of the key factors that the five general partners examine when evaluating a pitch is a well-defined group of target customers, patented technology, and an experienced founder with a track record of success.
Red Flags đźš©
“The problem with tiny winners in big markets is that they will be eliminated by one of the larger competitors and go bankrupt,” Zacha said.
Bruck agreed, “If a founder says they have no competitors, that’s a big red flag. Even if nothing else exists like your product or service, customers could still do nothing,” he said. “That is competition.”
Furthermore, the strength of the founding team is of utmost importance.
“At the end of a pitch, we ask questions. If a founder focuses too much on selling the idea, and they’re not answering our questions directly, they’re not getting an investment,” Zecha said. “If they can’t read the disappointment on my face, that means they can’t read the room, which means they probably aren’t a good sales person, which means they probably won’t be successful.”
Shaffer said his number one red flag is when a founder is dishonest and unrealistic about their capability in the market.
“Founders say it’s a billion dollar market, and if we get 10 percent of it, then we will be successful,” he explained. “But, it’s not that easy.”
Shaffer followed that up by saying any dishonesty at any point in the process is a huge red flag, including not disclosing key details.
Perhaps most importantly, all three of the panelists agreed that the biggest red flag is a founder who is considered a “brick.” This is a person who does not soak in advice. Any constructive criticism deflects off them, and they’re not coachable.
In addition to the honest, brutal funding panel, the event also featured a look into Community Development Financial Institutions, FundTN info, a look at the entrepreneur centers, and a session on crowdfunding.
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