Sanjay Reddy
More than 102,000 workers in U.S.-based tech companies have already been laid off in mass job cuts in 2023, according to Crunchbase. Yet for early-stage startups, the outlook isn’t as bleak as the headlines make it out to be — conversely, there’s a huge opportunity for scrappy founders in a downturn. A down market can provide investors with better entry pricing, more time for proper diligence and bigger returns in the long run; early-stage venture capital should be more than prepared to bet on great entrepreneurs in 2023.
Early-stage venture funding is unique. Unlike a Series B or C round, there isn’t a ton of data and metrics to review. Because of this, investors need to rely on the founders to convince them there is a market for their product and that they are the founders to make it happen. As we enter a market downturn, finding and cultivating investment-worthy founders is more important than ever. Whether to invest lies at the intersection of the founder or management team’s mindset, ability and motivation.
Seek out founders with a true entrepreneurial mindset
Early-stage investors need to pick entrepreneurs with a growth mindset. It’s as simple as that. Entrepreneurs that have a strong desire to learn, embrace challenges and aren’t easily knocked down, persist in the face of setbacks, learn from criticism, surround themselves with those that are experts in their field (and trust them), and find lessons and inspiration from other’s successes.
As a fund, we want outsize returns. To deliver those outsize returns, we need to go after a significant total addressable market and challenge to be solved. For an investment that supports a venture outcome, we need to invest in a founder who can stay the course through inevitable challenges. You also need to be sure that the founder you’re investing in wants the same things and won’t bail out on the first exit offer.
In early-stage companies, the focus or thesis can transform as often market conditions and demand for the solution do. That’s why, though opportunity sizing is important, it’s not the determining factor. Early-stage investors must rely on the entrepreneur’s mindset to deliver the outcome; numbers on a spreadsheet can’t do that.
While a founder’s education and work experience come into play, it’s an entrepreneurial mindset that is essential. Willingness to take a risk or walk an untraditional path and ultimately learn from it are critical attributes. So is persistence and grit. Many founders we work with have past startup and founder experience, including some failures. A good entrepreneur is an outlier; they see things others don’t and are willing to go to the wall to back those beliefs.
Questions we ask when sussing out a founder’s mindset include:
- How have you previously led your team through a crisis?
- Take us through a smooth/rough day at your company. What went well/wrong and why?
- How do you motivate your team to get to that next big milestone?
- Who is a mentor of yours? What and how did you learn from them?
- Tell me about a disagreement you’ve had with your executive team. How did you come to a compromise?
- How did you handle layoffs at your past company?
- When challenged in the past, how did you respond?
Assess founder ability on multiple fronts
Ability encompasses multiple factors, including domain expertise, network, recruiting talent, flexibility, imagination and the ability to raise upstream financing. When identifying entrepreneurs, we evaluate multiple factors through both the questions asked and the quantitative and qualitative information gathered.
Typical questions include:
- Do you have startup experience? For example, have you worked at, helped scale or founded a startup before?
- Do you have experience raising institutional funding?
- How large is/was your team?
- What were the outcomes of the startup(s) you worked at? Were you acquired? IPO? How did you exit?
- Have you worked in this sector before?
- Do you have a network that can accelerate your commercial traction?
- Do you have control over your finances, both personal and business?
- How do you communicate your message to investors, coworkers, potential partners, etc.?
- Have you touched all aspects of a business before? Do you have a general knowledge of how an organization runs smoothly?
Gauge motivation and confidence
So, what can make or break a VC’s decision to move forward with a company? Motivation! Determining motivation is not pure art — there are several factors to consider such as autonomy, relatedness and competence.
An investment-worthy entrepreneur must genuinely believe in their company and be determined to deliver a big outcome. Successful founders don’t find building a company to be work; their company is part of their soul. For an entrepreneur, their company isn’t just business, it’s personal.
Whether to invest in a company ultimately comes down to overall confidence (or lack thereof) in the founders. This confidence is typically based on pattern recognition from the thousands of entrepreneurs we have evaluated over our collective careers. It’s related to the way they talk about their business, their co-founders and employees, how they talk about the future and more.
Some of the questions we ask include:
- Why are you doing this? Passion? Mission? Chip on the shoulder? Belief?
- Have you experienced the problem you are trying to solve either in your personal life or business life?
- Are you committed to delivering an outsized return or will you take the first offer?
- Do you have a concrete business plan?
Now is an excellent time for venture capitalists to identify and nurture great entrepreneurs with great ideas. Great business ideas can still thrive even when the economy is not doing well. Just look at the many high-profile startups that launched during economic downturns and recessions and have become successful businesses and are still thriving to this day. With the right guidance and support these entrepreneurs can turn their ideas into flourishing businesses and investors can expect great returns.
Comment