Startup Quality & Investment Quality

Below is the ‘Tip of the Week’ from the Podcast Ep41: The Exit (John Huston):

Today John spoke about how most angel investors are hunting unicorns and are focused on the quality of the startup. This is where it all begins, right? We look for great ideas, exceptional teams, in large and growing markets… and hopefully with traction too. But John made a case that really resonated with me. He said and I quote:

“Focus first of all on, can this be a great investment, not just a great company.”

If we were in a vacuum and all the best startups succeeded and the rest did not, the deal, equity and available capital wouldn’t matter. But we’re not in a vacuum. And all startups die because they run out of capital. If the angels are too aggressive, taking too much equity or including predatory terms, the startups ability to raise a series A will be impacted. No VC wants to jump in to a messy cap table with shady board members. If not enough capital is raised to reach the necessary milestones for a subsequent fundraise or strategic acquisition, this can also kill a perfectly good, accretive, value producing startup.

Conversely, if the deal doesn’t protect the initial investors and give them appropriate equity compensation for their risk, then even in very good outcomes for the startup, the investor may get a poor return or no return at all. Clearly, this too does not encourage a symbiotic, healthy ecosystem where angels can re-invest proceeds in the next generation of successful startups.

While the quality of the startup is always in focus, it’s the quality of the deal that allows the value to be realized. As Jerry Neumann mentioned on the show… Paul Graham is famous for his advice to angels: “Don’t spend much time worrying about the details of deal terms. That’s not how you win. You win by investing in the right startups” Yet, this is the same Paul Graham who invested in over 600 companies, at essentially the same terms, with a $225k pre-money valuation. That facts suggest that his is an index strategy and deal terms are of critical importance. And as was evident from John’s experience in today’s interview, when the quality of the deal was suspect, he has picked big winners and received no quality return.

That’s it for today. Again, it would be great if you could hop on the Angel List syndicate page for New Stack Ventures and either back us or give us a follow. It’s very easy to setup an account if you don’t have one and it’s a great way to show some support without any obligation.