“Too early”

In two of my online classes I have the students play the role of angels deciding if they want to invest in a (fictitious) company. In the simulation the students are all angels, members of the same angel group, and a the deal before them is being championed by several of their peers from the angel group.

This simulation does a wonderful job of getting students into the mindset of angel investors, far better than any lecturing I could do. But one thing that comes up every time for them (and quite frankly in many angel groups as well), is the “This is too early.” Here is an excerpt from a post I made to them in class that I hope you find of interest on this ongoing issue…

In the simulation you discussed heavily how advanced the company was. This was fantastic. You perfectly simulated something I was hoping would come across… The startup is ALWAYS “too early.” There are always just a “few” things that if the startup did, would make the investors comfortable. This is true NO MATTER HOW FAR ALONG THE COMPANY IS. Well, maybe not 100% of the time. Probably only 99% of the time.

It is human nature to notice that something “isn’t done” and to REALLY want the obvious missing pieces to fall into place. Of course, once the startup completes those tasks, there are NEW things they are missing.

Example:
* I year ago (in the simulation) Evenplay [the fake company they were considering investing in] was just the two founders and a board of advisors. They had launched some games and had some sales. Nothing much to write home about.
* Then They added great mentors (decreased TEAM risk)
* Next they recruited an impressive CEO (decreased TEAM risk)
* Founders kept 10% growth month-over-month for a year (decreased market risk)
* Next the CEO brokered their first strategic partnership (showed she could deliver business-to-business strategic partnerships, further lowered market risk.)

Those of you who said no to invest in the company all said the company would need a CTO for you to feel a lot more comfortable. Of course, once they HAD the CTO, you would want to see proof the CTO could deliver on handling 10x or 100x as many customers… 🙂

Many of you were worried about the viability of the jump to the [next adjacent] market. If EvenPlay made the jump to this new market with a first product that had respectable sales, the next thing investors would have asked for is “a second product, I want to know this isn’t a one trick pony.”

After that they would have noticed how customer support is clearly critical to the company’s success. Has EvenPlay identified the right VP of customer support? How is the customer support team scaling up? Customer support is labor intensive – can they prove they can handle so many hires? Why not go to India…

You get the idea :).

ALL of those questions are PERFECTLY VALID. The key is understanding this… the VALUATION.

There is a risk that the company will fail. Each time they accomplish a milestone, the HOPE is that the risk decreases a bit. We humans like to decrease risk, we are psychologically hard-wired to hate pain/risk more than we love an equal amount of pleasure/opportunity.

That is what the valuation system is for. A young startup like EvenPlay is pricing itself at $1 million. That means that if you wrote them a check for the full $1 million today you would own 50% of the company (they WERE worth a million, you added a million, so they are now worth 2 million, therefore you own 50%). If you wait until they have the CTO, first successful product in the low vision market, etc… the valuation will be much higher – probably many times higher. Therefore the amount of equity you can purchase with your dollars is many times less.

Of course, if the company fails it doesn’t matter how much you own, you still get ZERO! THAT is the balancing act investors have to play.

And now think about how that effects you. YOUR venture will NEVER be “done” enough. You have to accept that. You have to build relationships early so you can get a list of “Do X, Y, and Z and I’ll be interested.” Then come back when you have done X, Y, and Z. The sooner you meet investors, the easier it will be to accomplish X, Y, and Z. And investors almost always want to see you do something AFTER they meet you, regardless of where you are when they meet you. Just human nature… no past “proof” matters as much as the proof “I” see with my own eyes. Not rational, but that is how it is.

In fact, you will find that all of this is true for ANY source of large funding – big bank loans, big grants, etc. People like to see momentum. So show it to them.

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One thought on ““Too early”

  1. Wow! Making students angel investors certainly prepares them for the real world of entrepreneurship and investors. Some don’t even teach students about angel groups or investors. Students are simply taught to find investors via VCs or through banks and lending companies. Sounds like an interesting class discussion.

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