Choosing An Executive Management Team

For start-ups seeking funding, one of the most important features in attracting investors is undoubtedly having a strong management team.  While most everyone agrees on this fact, not many say  what the ideal management looks like.  Some will tell you, "Long resumes of relevant work experience", while others insist, "Your team must have a large network to add to your own".  In Investopedia's article, "How Venture Capitals Make Investment Choices" Ben McClure insists that VCs look for experienced management teams that have success building businesses that have high returns for investors.  While these are not bad aspects to look for (in fact I think they are necessary aspects to seek after), I believe that many do not look for the most import aspect of a team: Passion and common beliefs.

Passion

When I say passion, many different images or associations can come to mind.  Some would say that when someone claims to be passionate that what it really means is, "I have no experience but find this area really fun".  However, I would say that if one has true passion for an industry that their start-up is situated in, this really means, "I spend all my time researching this industry and know exactly how to make this business successful because it's all I do.  I can't see this business failing because I won't let it fail."  When someone has true passion for what they do and the company they work for, they have a sense of ownership in the company and will protect its success like a mother protects her child.

With that being said, an individual still needs experience to be able to carry out all that their passion has just promised the investor.  However, I believe that if passion is the first filter that investors use to judge an executive management team, they will invest in stronger companies.

Common Beliefs

 

When constructing a strong management team, it is essential to make sure that your team shares the same values and beliefs that the company you are constructing shares.  Now if you can't nail down what values and beliefs you want your company to have, I would say you have another issue.  Knowing why your company exists and being able to find people that want to further your company's cause are essential to the success of your business.  If a management team that has conflicting views on the direction of the company is constructed, business meetings will be run exactly like a congress that is split 50/50 republican and democrat: nothing will get done.  

By finding a team that is passionate about your business and shares your beliefs, your company will be bound for success.  Take note, this is assuming that your business is feasible to begin with.  If your business is trying to sell something that no one wants then your business will still fail with a management team of Bill Gates, Warren Buffet, and Steve Jobs from the grave.  The point is, to ensure healthy long term growth, you must have a strong management team.  By constructing a team this way, if will become evident to investors that your team has what it takes to make your business successful, more importantly, want to make your business successful.

Choosing a Niche

When picking companies to invest in, venture capital firms must be extremely careful in choosing which to fund.  However, the goal of this wariness is not so much to invest in all companies that will give back a significant return.  Instead, these VC firms will look to invest in an array of companies in hopes that just one or potentially two companies will bring a significant return of at least 10 times the amount invested.  VCs know that roughly 50% of the companies won't return any of the invested funds, and the firm therefore need to make up these losses with companies that continue to grow and ideally will eventually have their IPO on a major stock exchange.

So what exactly do these firms look for when deciding which company to invest in?  There are a number of things that companies look for in finding the best companies for their money.  Here are three of the top things that venture capital firms look for when investing their fund:


1. Stage of Company

For VC firms, it is extremely important to look for companies that are in the later stages of development.  Companies that already have at least around one million dollars in annual sales are much more attractive to VCs.  The reasoning behind this is quite simple: the company already has had success selling its product or service and it is more likely that the company will be able to increase sales with more capital.  If the VCs see that the business is scalable and already profitable, the company is extremely likely to receive investment from the firm.

Some potential problems with ruling out companies that are in the seed or early stage is that a lot of companies with great ideas get overlooked.  However, the risk involved in investing in these companies usually outweighs average returns; VCs can't be wasting their time on investigating the possibilities of success with these firms.  Especially because it is nearly impossible to give a company that has no sales a remotely close evaluation.

2. The Product or Service at Hand

VCs like to see that the companies they are funding have innovative products, the kind that change the world.  However, in today's business environment it is extremely difficult to come across a completely novel idea.  VCs aren't necessarily looking for companies to reinvent the wheel, but companies need to go beyond a single competitive advantage in today's market.  Suppose a VC decided to invests in a company that simply makes a product cheaper.  By the time this company breaks through into the market and gains a considerable market share of the industry, the competitors may have already innovated their product to make it cheaper or better, therefore causing a major threat to the firm.

Of course this goes without saying that there needs to be a market for the product created.  If a superior product is created that no one is willing to buy, the company is out of the running.

3. Management

When looking at potential companies to invest in, VCs know that the management team is key to success.  However, this can be extremely difficult to gauge.  Many VCs want to see commitment (mainly time in addition to funds) in their company to know that the management team is committed to the success of the company.  Although this is not a definite sign that the team is completely committed to seeing their company succeed, it is usually the best indicator that VCs can get.

In addition to having the knowledge that a management team is committed, the team must display relevant experience to their respective positions.  99.9% of the time, VCs see a red flag when team members don't have relevant experience to offer the company and position.


In addition to these three points, VCs also intently follow trends to see what industries and ideas are new this year.  If current industries are becoming more popular, obviously a VC is more likely to invest in it given its bright outlook.


My View on Choosing Successful Companies

In choosing companies to invest in, the areas in which I would weight more would be more towards the people behind the business, the management.  Sure there need to be prerequisites that are met: a fantastic product, a desirable stage of the company, a flawless business plan, etc.  But the truly successful companies are born when there exists an entrepreneur with a burning desire to revolutionize their industry.

When one can dig to the core of a founder and discover what is truly driving them, the decision becomes clear.  If those motives are fame, fortune, power, etc., the answer is no.  Because there will be a time when it appears that the company has lost all hope of ever achieving these goals.  However, when a founder is set on making their business succeed because it is their passion in life to do so, the answer is obvious.


Therefore, a founder with a mission to change the world is the icing on the cake when it comes to choosing companies to invest in.  A company that has this along with all the points mentioned above, they are destined for success.

Venture Capital Experience: A Vocabulary Lesson

Within the last 70 years, the way in which individuals and groups in the United States have gone about funding start up companies has changed dramatically.  With this change has come many different paths to funding one's company.

Today, there are 3 main sources of funding for start up companies: angel investors, super-angel investors, and venture capitalists.  Each of these funding sources has their own advantages and disadvantages depending on what a company is looking for.  But with new terms such as these types of investors, it's easy to mix one type of investor up with another.  Let's take a deeper look at who each one of these investors are and how each one differs from the others.

Angel Investors
Angel investors, usually referred to as simply angels, are individuals that use their own money to invest in start ups in exchange for most commonly equity in the company.  These investments are typically in the range of 50,000-200,000 dollars, however they can far exceed this range on either end of the spectrum depending on the angel.  In general, angels have in the single digits of companies that they are currently funding.

abc's Shark Tank.  Source: abc.go.com

In abc's recent television series, Shark Tank, contestants have a few minutes to give the judges their business pitch in order to convince at least one of the angel investors that their business is worth investing in.  At the end of the pitch, the angels ask questions and they make an offer to the business owner, offering a certain amount of money in exchange for a percentage of equity of the company.  The offers range based on the angel's valuation of the company and percent euity requested.  This show is a great example of the typical process one must take in order to obtain funding by an angel or group of angels.

One notable advantage that the angels have over venture capitalists is the quickness in funding a company.  Typically, receiving funding from a venture capitalist firm will average about six weeks.  Angels can also be more driven by relationships and the desire to be a part of a company again and therefore may be willing to settle for a smaller portion of a small.

Venture Capitalists
For companies that are willing to give up more equity in exchange for more capital, seeking funding from a venture capital (VC) firm is the route to take.  VC firms are managed by a group of investors called, not surprisingly, venture capitalists.  VCs will raise a pot of money for each round of start ups, typically at least 100 million dollars.  After the firm has found enough investors to get their desired pool of money, the firm seeks out companies to invest in.  A typical firm will look to invest in 15-20 companies for any given pool of money.

A VC firm knows that it won't make a profit on each company, and that's why they pour their money into various different companies.  Their hope is that one or two of the companies they invest in will eventually reach their IPO on a large public stock exchange.

Super-Angel Investors
Like angels, super-angels are are individuals looking to invest in companies in exchange for equity.  However, super-angels invest other's money in addition to their own, making them the middle ground between angels and venture capitalists in terms of amount of capital.  Typically, super-angels invest 500,000-2,000,000 dollars, but again there are always extraneous cases with extremes on both ends.

Super-angels are a very new category of investors when it comes to the market of investing in start-up companies.  They came about for the purpose to fill the gap of capital between angels and VC firms.  Because super-angels are able to invest about the same amount of money as a venture capitalist firm, do it a lot quicker, and ask for less than what a venture capitalist would normally ask, super-angels are proving to be a big threat to venture-capitalists.  With this new competition arising, it's evident that VCs will have to move toward being more efficient and being able to invest smaller amounts of capital to more companies.


Although these are the 3 main sources of raising capital for new start ups, there is another source of funding available to a wider array of companies called crowdfunding.  The most popular and successful website based on crowdfunding is Amazon's Kickstarter.com.  Here companies may pitch their businesses to the world and offer rewards for "backers" to buy.  The largest project thus far has raised over ten million dollars, although the average amount is five thousand dollars.  Although crowdfunding is a completely different ballgame, this alternative is still available to some companies requiring a small amount of capital.


The last phrase that gets thrown around a lot is incubator, and most common of the incubators, Y Combinator.  An incubator is a company that takes in early-stage companies to help them with all the aspects of starting their firm usually with the agreement that the incubator will get equity of the company in exchange.  Y combinator is a big threat to all these forms of investment possibilities for start-ups because they are ensuring their success when they actually help these companies refine their business for three months.  Although Y Combinator only gives out about 20,000 dollars to most companies, their expertise that they offer to the companies along with introducing them to other sources of funding is worth much more.  And when they're asking for only 2-10% of your company, who wouldn't take that deal?


I'm sure in the next few years we'll have many more confusing terms pop up in the world of venture capitalism and start-up funding, but I hope this explanation has helped with terms being thrown around today.