Rule #1 in Angel Investing - It’s All About the Team

Note: This article is the second in an ongoing series for Angel Investors. To learn more about developing the key skills needed to make great investments, download this free eBook today Angel 201: The 4 Critical Skills Every Angel Should Master or purchase our books at Amazon.com.

Angel investing: How to evaluate deals
Image by Laurence Horton

Great ideas are a dime a dozen.  Living in the Boston/Cambridge area, we are surrounded by some of the most innovative researchers in the world working at institutions like MIT and Harvard. I’m pretty confident when I say, in Boston, hardly a day goes by when some graduate student or professor doesn’t invent a new product, discover a new molecule or create a cool app. Unfortunately, without a great team behind that new product, it’s doubtful that a great company will result.

There is an old saying that goes something like this… “I’d rather invest in an A team with a B plan than a B team with an A plan.” Without a doubt, we feel this is the most important point for investors to embrace. Once you understand how critical the team is to a successful outcome, the greater success you will have as an investor. As a long term serial entrepreneur and a successful angel investor, I asked Ham to tell me how he evaluates teams and differentiates the A teams from the B teams.

Q: Ham, let’s start with the person at the top. How do you evaluate startup CEOs and what are the most important characteristics you look for?

First and foremost, I look for integrity. That character trait might sound obvious and a bit trite, but I feel it’s very important to be on alert for trust issues when you are interacting with an entrepreneur. From the initial meeting with the company, during the due diligence process, and finally while negotiating the deal, I want to make sure the CEO is being honest and negotiates in a fair manner. If I sense any duplicity at this early a stage, I can be sure that things will only get worse as the company progresses through the challenges faced by all startups.

That leads me to my second character trait, tenacity. It’s not easy being a startup CEO. The pressure to succeed is enormous, and CEOs struggle every day to motivate their team. Life in a startup is a series of highs and lows not too dissimilar from riding a roller coaster. One minute life is great as you ship your first product. The next day you hear back from customers that your product is lousy. It takes resilience to handle the good and the bad that a CEO faces on a daily basis. A CEO’s tenacity allows her to continue the battle to succeed even when others would give up in despair.
 

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Q: Okay. Those make sense, but there has to be more in the mix than that? What else do you look for?

Next on my list is a combination of IQ and EQ. In other words, a CEO needs to be smart and self aware. By “smart”, I mean the CEO has the intelligence to discover a major market opportunity, and articulate a plan that will address that opportunity. The CEO has the intelligence to develop high-level strategic plans, and the problem solving skills to deal with day-to-day tactical and execution challenges.  By “self aware”, I mean the CEO works well with a great team and is willing to take guidance from close advisors. In other words, the CEO must be coachable. A great CEO wants to hire “A” team members who are better than he is for the job being filled.

A deep market understanding is an important skill set for a CEO because it provides the North Star from which the CEO will navigate the company. Great CEOs are two steps ahead of the competition because they have an inherent understanding of where the market is heading.

The final characteristic I look for in a CEO is presence. I define presence as follows... A CEO with presence has the leadership charisma to command any audience. This type of charisma allows the CEO to take charge whether speaking with employees, customers or investors. When the CEO walks into a meeting, you know who is in charge! Furthermore, this ability to command an audience gives the CEO a unique ability to create a winning culture. Building a winning company culture takes constant care and attention from the CEO, and the best way to tend to this task is by communicating a compelling story on a regular basis to the entire company.
 

Q: Wait - what about experience?  What role does experience play in startup success?

This is a trick question, right? The obvious answer is that experience is critical. You should always back serial entrepreneurs with decades of market experience. Well… that’s true in some cases. If you are looking to build the next generation of product or service in a well established market, having a few grey hairs and a deep network of contacts is probably the right way to go.

But, suppose you are trying to totally disrupt a market. For example, you are Jeff Bezos and you are looking to change the way people buy stuff. When he started Amazon, online retailing was in its infancy. Lots of market experience didn’t exist. He had to make it up as time went on. So disrupting markets takes a very different type of entrepreneur. Success at Amazon had very little to do with experience and much more to do with the ability to try new things and learn as fast as possible!
 

Q: So you hear the CEO give her pitch and then you spend an hour or two digging into the company to learn more. How are you able to really get to know the CEO and figure out whether she has the key characteristics you are looking for?

The first step that most investors take to learn more about the CEO is to reach out and perform reference checks. Some of the references will be from contacts that the CEO provides to you. Other contacts will be people in your network that know the CEO. This type of background information is useful if you ask the right questions. At Launchpad, we have a well defined set of questions we use to guide these interviews. It helps us uncover red flag issues that we need to keep an eye out for, and it helps us apply resources to help the CEO be successful.

Personally, I find the reference checks to be useful but not sufficient in helping me get to know the CEO. I like to take things one step further. In addition to typical due diligence meetings, I arrange for time with the CEO in a non-business setting. For example, I like spending an evening with the CEO at dinner or a sporting event. Hopefully, our conversation flows smoothly with most of the discussion focused on personal topics. This way I get to know the CEO in a different context.
 

Q: Moving beyond the CEO, what skills do you look for in a startup company team?

There are four skills that I look for in a startup team. Given the small size of an early stage company, sometimes these skills are part of the CEO’s repertoire, but I like to see them incorporated in the skill set of the other founding members.

  • First, I look for selling skills. Whether talking to prospects, investors or future employees, the management team has to be able to sell. If you ain’t sellin’, nobody’s buyin’!
  • Second, I look for technical skills. I invest in tech companies and so I expect the company will have a great product that will build some competitive barriers to entry.
  • Third, I look for a deep market awareness. As I discussed in one of the above questions, this market awareness is critical for developing the company’s strategy.
  • Fourth, I look for product management skills. This is closely related to market awareness, because it requires the ability to listen to customers and understand the competitive environment. It also requires the ability to translate market needs into a plan that engineering can actually deliver in a timely fashion given limited company resources. Product Management is an often under appreciated skill set. A greater number of tech companies would succeed if they invested more in this critical resource.
     

Q: What’s the right size for a startup company founding team?

It’s not as though there is any magic number here, but I tend to like founding teams with 2 or 3 people. Here’s my thinking on why that’s the right size. To start with, we won’t invest in a company that has only one person involved. If a founder can’t convince a co-founder to join him in this crazy startup, why would the founder think he can convince investors to put money into the business?? With 2 co-founders, the company is moving in the right direction (read more on Key Founder Issues). Hopefully, the team has complementary skills that help round out the need for the key skills I discussed in the previous question. And, if 2 people can’t pull that off, then 3 team members usually can.

Once you move up to founding teams of 4 or more you run into a lot of issues with coat-tail riders, founder dilution, outgrowing the co-founders who aren’t producing, etc. Another issue to be aware of in this context is that founders always obsess about negotiating valuation and they can become overly focused on issues relating to dilution. That makes little sense when you consider the deadweight college buddy / co-founder who owns 25% of the company. Fussing about dilution by bringing in great investors and capital while having no-ops on the team, is like locking the front door but leaving the back screen door swinging in the breeze!

Want to learn more about building an angel portfolio and developing the key skills needed to make great investments? Download Angel 101: A Primer for Angel Investors and Angel 201: The 4 Critical Skills Every Angel Should Master for free, or purchase our books at Amazon.com.