What Investors Look For

Professional investors – those who invest for reasons other than that they love you – understand intuitively the seven domains, even though they, like entrepreneurs and the rest of us, do make mistakes:

(i) They confuse markets and industries, mistaking the attractiveness of one for the attractiveness of the other.

(ii) They overlook the distinctions between the macro- and micro-levels. Like lemmings, they sometimes follow one another into large and growing markets, falling into the large market fallacy.

(iii) They fail to ensure that what their portfolio companies bring to market offers clear and differentiated customer benefits – falling into the better mousetrap trap.

(iv) They forget to examine whether the initial advantage brought by those benefits can be protected and/or sustained.

(v) They mistake personality, chemistry or a few lines on a CV for an entrepreneur’s ability to execute on CSFs. They fail to determine an entrepreneur’s connections, or lack thereof, up, down and across the value chain.

In short, professional investors, like the rest of us, are human. Nonetheless, professional investors – angels and venture capitalists – do know what they want in the deals they back. In general, they like to see:

(i) large, growing markets supported by favourable macro trends;

(ii) attractive, competitively forgiving industries – four or five favourable forces;

(iii) market offerings that resolve real customer problems, by delivering clear and differentiated benefits not available elsewhere;

(iv) innovations that can be defended over time through patents or superior organizational processes and capabilities, having economically viable business models;

(v) entrepreneurial teams whose missions, aspirations and propensities for risk are compatible with their own;

(vi) entrepreneurial teams who can execute on their industry’s CSFs;

(vii) teams well connected up, down and across the value chain.

Can they have it all in any particular deal? Exceedingly rarely, otherwise their success rates on individual investments would be far higher than the one or two in ten that most venture capital portfolios achieve. So, what do they do? They take risks in pursuit of greater rewards. They bet that a shortcoming on one domain or another will be compensated for by strength on another. That a strong enough team will meet the challenges that will inevitably be encountered. That others won’t soon see the opportunity you and they see.

In contemplating these risks, however, investors have identified certain red flags or warning signs that tell them when the risks are too high, regardless of how exciting the opportunity’s other elements may appear. They’ve done this the hard way, through unpleasant experience. Among these signs are the following:

(i) Lightweight (or even non-existent) market research. ‘What are the customers saying?’ asks Joseph Bartlett, a partner at Morrison and Foerster LLP. ‘This kind of interchange has no substitute; it has to happen before you solicit money from venture capitalists’.7 True, there were a couple of years in the late 1990s when ideas scribbled on cocktail napkins somehow won funding. But those days are long gone.

(ii) Better than market research, even, are hard data that customers have actually bought or will buy. Actual orders from a website, letters of intent, or other indications of real demand are powerful testimony. What people say, in a market research setting, is not necessarily what they will do.

(iii) Overly confident assessment of competition. ‘It always puzzles me when I come across plans that claim they have no competition’, says Daniel Kim of Circle Group Internet.8 Virtually every customer need is being satisfied presently, in some way, however imperfectly. Your competition may not look like you or what you plan to offer, but surely as day follows night, it’s out there. If there’s no competition, there’s probably no market either!

Entrepreneurs who have carefully assessed the seven domains don’t make these three mistakes:

(i) The research has been carried out.

(ii) Evidence of genuine demand has been gathered.

(iii) Competition – direct competitors as well as substitutes – has been identified and assessed.

Thus, in dealing with investors, the seven domains framework gives you the tools to speak their language of risk and reward. It takes you beyond blind faith – that everything is wonderful about your opportunity – and enables you to understand deeply your opportunity, warts and all. It enables you to answer for prospective investors your two key questions, which happen to be their key questions, too:

(i) Why will this work? What are the one or perhaps two domains that lend to your opportunity a compellingly positive story?

(ii) Why won’t this work? Where do the risks lie, and what is there about your opportunity and your team that effectively mitigates them?

In short, the seven domains analysis puts you and your investors on the same page. It aligns your perspectives. It gives you a common language with which to discuss and debate the merits and flaws that each of you sees in the opportunity you wish to pursue. And, as we’ll see in the next and final chapter, it provides a solid, evidence-based foundation on which to build a compelling business plan