It is essential for any founder seeking investment to understand what qualities investors are looking for in the start-ups they choose to invest in.
As a successful entrepreneur and an experienced investor, Tim Bruemmer knows exactly what investors want to see when they are pitched to by a start-up. In this article, we speak to him about what he looks for as an investor.
I am currently managing partner at IOI Partners and Sagian Equity after 30 years as an entrepreneur and R&D leader.
I obtained my Chemical Engineering degree from UC Berkeley and started my career in Kodak’s research laboratory. After 5 years of scientific research work, I left Kodak and began consulting on laboratory automation prior to co-founding SAGIAN (now Beckman Coulter) which specialised in providing laboratory automation solutions to Fortune 500 companies.
I co-founded and sold multiple other companies while taking time away from Beckman Coulter ultimately finishing my career there as Vice President of R&D for the Life Sciences division.
In 2014 I co-founded IOI Partners to provide consultation on corporate innovation focusing on product development. Sagian Equity was co-founded in 2016 to make investments from seed to late stage in various start-ups of interest to the principals of IOI Partners.
Sagian Equity was started as an investment vehicle for a wide variety of companies. It invests in early-stage (seed) to late-stage for companies with a variety of interesting value propositions. Sagian Equity also provides support for screening and due diligence to the largest Angel investment group in Indiana, Vision Tech Angels, and provides consultation and advice to companies it chooses to invest in.
This starts with the market.
Is there a market need that the product will satisfy and is the market substantial?
Many entrepreneurs define their market so broadly as to be meaningless with respect to the product they are offering. For example, it’s not that relevant to quote the size of the automobile market when a company is planning to sell a better rubber for tires. It’s definitely important to understand what the estimated current sales of material for car tires are (Total Available Market – TAM) and what portion of that market is accessible to be displaced by the company’s product (Serviced Available Market – SAM) based on product capabilities and the company’s access to markets.
Once a defensible SAM is established, one has to understand the growth rate for the defined market(s). Is the market for the product or solution growing rapidly (>10%), growing modestly (5-10%), or growing slowly (<5%).
A business plan cannot be expected to be “right”, especially in the early stage of a company. In fact, we expect the plan to change as the team learns. There should be some thoughtfulness in the plan regarding what is important and what is not indicating an understanding of the market and how to serve it.
There should be some indication of how the business could become sustainable, quantification of the market (see TAM and SAM above), and how the market can be penetrated (or created in some cases). We mostly use the business plan as one way to evaluate the competence and maturity of the team, their understanding of the market they plan to serve, and their ability to identify what’s critical to success and formulate and defend a plan to act on that.
All business plans have some form of “hockey stick” growth model. Very rarely are those models realised. As a company moves away from relatively slow growth at lower volumes to larger growth at higher volumes many factors will come into play to self-limit that growth.
For a specific business model some of these factors can be anticipated, such as scaling production or the need to convince customers to switch as opposed to simply attracting first-time customers to a product or service in order to continually increase market share. For these, an important part of the evaluation is understanding how the management team has modeled their growth objectives and whether and how they propose to manage those critical-to-the-business obstacles along the way.
Some other factors, like emerging competition in a new space or future falling unemployment rates making it hard to expand a service model cannot be specifically anticipated and require confidence in the team to navigate the inevitable uncertainty. This confidence will come from other sources including the plan but irrational exuberance (amazing results with little justification) within a business plan is not an inspiring approach to gaining that confidence.
At a minimum, a business must have a management team that clearly understands its market and how to serve that market. It must have access to sufficient expertise to bring its product or service to realisation. The team must be mature enough to recognise when the current path is flawed and be willing to adapt as obstacles are encountered. An entrepreneur or management team that appears too entrenched is not one that we find worthy of backing.
Furthermore, we would love to see a management team that has great connections in their industry, is energetic and unencumbered enough to burn the candle at both ends through the myriad problems they will encounter (usually implies some youth), demonstrates competence in their respective roles with all key roles filled and are creative and adaptable enough to solve problems and change their plans as they learn.
…. we’ve never seen that team.
There are usually many holes in this wish list but if the right subset is present and the missing elements can be hired or mentored into the mix that is a great start. All that said, competence in some key positions (depending on the company state and market space) and adaptability of the founders are two key elements. Competence almost always requires some experience in the market space to lend credibility to the fact that the team probably did not miss any big flaws to their plan of bringing their product (or service) to market.
A high potential business almost always starts and ends with the entrepreneur or management team. Mediocre management teams in high-growth markets are oftentimes successful and can make for good investments. In this case, you’re betting the market pulls along the management team or they grow into the opportunity.
A high potential opportunity is one where the market is compelling and the management team is truly outstanding. Outstanding in this case doesn’t just mean the management team is experienced or experts in their field – it means that the management team demonstrates the competency and willingness to do what it takes to win and understands that winning means the investors win too. A great management team in a great market will almost always find the right product-market fit. It’s almost never the original concept. Finding that management team that has a grasp on how to adapt and react to a dynamic market is clearly a high potential opportunity.
It’s always important to see demonstrated knowledge of the market. What is currently missing (true market need) and how to address it in the context of the particular market is important to establishing confidence in the team. As alluded to above, the adaptability of the founders is key especially in the early stages of a company and especially for a company that is attempting to open a new market. It is important to focus on what is critical and not waste time on much else but that focus can’t come at the expense of learning and adapting to that new knowledge. This is somewhat difficult to evaluate during a pitch or with leading questions on follow-up. A good story about how the team arrived at their plan (perhaps having started with one objective and identifying the flaws and correcting to the current), as well as, personal conversations (when possible) and interviews with existing investors can be used to evaluate this.
A pitch that leads with the value/merits of the product concept is as close to dead on arrival as one can get. We do not invest in products. We invest in markets and teams. The product concept is clearly what grabs our attention and opens the door but that is rarely the primary reason we invest. This is really indicative of the key red flag of a company that is basically a solution in search of a problem. This is common amongst technical founders who believe they have found a better way to do something but don’t recognise that the market may not actually need a better mousetrap or is not likely to be receptive to the workflow changes required for them to adopt the product/solution. This lack of focus on establishing that there is a true and demonstrable market need is a great way to waste a lot of time and effort towards no investible end.
Another killer to an investment is a founder who is not aligned with investor interests. This can sometimes be hard to spot upfront. However, it is usually unproductive to engage in a business with:
(1) no clear exit strategy – the team hadn’t thought about it enough to include the possibility in their pitch
(2) indications that the founder is looking for a career in the business rather than building value towards a profitable exit
(3) team expresses no sense of urgency in a timeline to exit. Rarely are investors philanthropic. By definition, investors invest to realise a return. Different investors have different thresholds for those returns which is why some investors pass on opportunities that other investors pursue.
We target a price that enables a path to a >10x return on invested capital, depending on the state of the company and availability of near-term exit opportunities. We don’t count on that return for all investments but if it doesn’t appear to be possible for a typical start-up that may not exit for 5-7 years then it’s not a candidate to offset the inevitable investments that may return 0-3x the invested capital in that time frame. If the time frame to probable exit is more likely 1-3 years and/or the product maturity in the market is higher and the management team is cultivating strategic exit partners we would invest expecting a lower total absolute return but similar ROI.
What we expect and what we get are normally very different. It would be helpful if the company would provide a one page executive summary of their business which includes some definition of the market, a description of the problem to be solved and why that problem is interesting, how they propose to solve that problem and how the market will value that solution. A brief bio on the management team is also important – which could be as simple as a link to a LinkedIn profile or a link to the company’s website with that information. The provided material should be foundational to the actual pitch. This allows us to do some simple diligence to prepare for the pitch itself.
Just a final reiteration, the product opens the door – the market and the team earn the investment.
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