I’m finalizing my biggest ever investment in a startup. Let me take you inside the research process I used to make this decision.
- Read the deal memo and deck. Simple, but you’d be amazed how many people don’t do this!
I read all materials, often multiple times. I extract key passages and take notes on them.
- Find growth rate and burn multiple.
For every company, I want to know how much money is coming in the door.
I also want to know how fast the revenue is growing. I calculate growth rates for the last 6 and 12 months.
For seed stage, I want to see a company tripling year over year. Around Series A, that may slow to double as the numbers get larger.
Growth is great, but we also want to make sure startups are capital efficient. If they’re burning $10 to get another dollar in revenue, they don’t have a viable business model.
So I take the most recent month or quarter’s ARR increase and divide it by that period’s burn. This produces the burn multiple.
I got a burn multiple of 1.6 for this startup, a very strong result.
- Calculate market size. I do what’s called a bottoms-up TAM.
I take all the potential customers and multiply that by the cost of the product. In this case, it’s a SaaS product used by in person stores.
I found that at least 2 million such stores exist in the US. At the startup’s average pricing of $4200 a year, this yields a healthy $8.4 billion potential market in the US alone.
I like to see that potential market around $10 billion or so. This gives me a chance of hitting a major outcome.
- Demo.
The demo is really undervalued. You can’t judge a product from a bunch of slides.
I want to see the product in action. And if it’s a consumer product, I want to use it myself.
Is it pretty? Is it easy to use?
If so, it just might sell!
- Meet with the founder. This step is crucial.
When I meet with a founder, I usually already have most of the financial information. What I’m looking for above all is to get a feel for a person.
I want to know his personal connection to the company’s mission. Will he give up if things get tough?
I often like to ask, “Who do you admire?” This founder smiled as he mentioned Elon Musk.
That gives me a sense of the scale of his ambitions.
I also ask myself who this person reminds me of.
In this case, he reminded me of two other founders I’ve met with, Brett and Aaron*. He calmly fielded questions and answered with enormous detail, just as they did.
Brett and Aaron both run billion dollar companies. Maybe this founder will too!
- Research competitors.
I look into the competitors the founder mentioned. But I also look for ones he may not know about.
In this case, I saw no serious competition. But even if there had been, it doesn’t mean the deal is a no-go.
It just means they need a great strategy to win.
- Research co-investors. The first question I get from most investors when I send them a deal is “Who else is investing?”
I don’t operate that way. I make my own decisions.
But I do want to know who else is in a deal. If top investors are joining, it’s a small plus.
Decision Time
I read over everything in the research document I’ve compiled. What’s the overall picture of this company?
In this case, I had a great founder taking on a huge, untapped market. His traction was impressive, reaching millions in revenue in just 3 years.
Since I first invested two years ago, he’d done everything he said and more.
So I decided to re-invest!
My last step is to write a short memo on why I’m investing. I keep it to a couple of hundred words.
This forces me to be clear on why I’m making an investment. Win or lose, I can go back and check the quality of my thinking.
In total, the whole research process took me a little over five hours for this company. That’s on the high side for me — I usually spend about 4 hours on research before saying yes to a startup.
For companies that don’t make the cut, the decision could come in just a few minutes.
But when I’m on to something good, I like to dig deeper. But I also keep in mind that eventually, I have to make a decision and move on to the next bet.
In the end, we can’t control outcomes. All we can do is improve our process.
My hope is that with enough carefully considered bets, I hit that home run.
How do you research a startup? Leave a comment and let us know!
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*Not their real names
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