HOW TO PICK A WINNING EARLY STAGE COMPANY

Venture Capitalists, Angel Investors, and Private Equity Groups invest in high growth companies. A small portion is in early stage companies. On “Shark Tank”, entrepreneurs with early stage companies pitch the “Sharks” for investment in their ventures.

Early in my career, I worked in M&A and Strategic Planning for a Fortune 500 company. They sent me to a Venture Capital Institute for me to be trained as a Venture Capitalist. When I returned, I managed a $100 million corporate venture fund. That training and my experience with early stage companies over the years has given me the skills in evaluating early stage companies.   There are a few key elements that anyone can use in evaluating these companies and predicting which ones will be successful and winners.

What is a winning early stage company? To most Venture Capitalists, that is one that has a high return on investment and that the market value increases significantly over the investment horizon. In addition, it would be a company that has high growth and scales rapidly. Most small companies should be agile and able to modify their products or services to remain at the forefront of the market.

It is helpful to determine the valuation of the companies as part of the evaluation. For valuing early stage companies, there are several different methodologies that can be used. The top 5 are:

• Venture Capital Method
• Berkus Method
• First Chicago Method
• Scorecard Method
• Rick Factor Summation Method

In evaluating the businesses and their business case, there are 8 basic elements that must be analyzed and evaluated. These elements are:

1. Market
   1. What is the current size of the market?
   2. If this is a new market, then do we have social trends or technology as enablers?
   3. What is the potential growth rate of the market?
2. Competitive Landscape
   1. What are the number and type of competitors?
   2. Are there any dominant competitors?
3. Barriers to Entry
   1. Does the company have a unique product or service?
   2. Does the company have any patents?
   3. Does the company have unique processes?
   4. Is the business capital intensive?
   5. Does it require significant time to develop the product or service?
   6. Is this the first company to offer this solution?
   7. What would prevent other companies from entering the market?
4. Value Proposition
   1. What problem is being solved?
   2. Are there other solutions to the problem?
   3. What is better about the company’s product or service?
   4. Who are the target customers?
   5. Is this business scalable?
5. Strategy
   1. What is the operating strategy of the company?
   2. What is the marketing strategy of the company?
6. Operations
   1. In an existing company, are there processes in place that can support the operations and serve its customers?
   2. In a pre-revenue company, are there processes that have been developed that can meet its needs initially and through a growth period?
7. Management Team
   1. Is the management team passionate about their venture?
   2. Do they have the drive and perseverance to succeed?
   3. Does the management team have integrity and behave ethically?
   4. Is there diversity in the skills of the management team to be able to carry out the plan, including the operations, sales, and financial management?
   5. Has the management team been involved in other successful ventures?
8. Financials
   1. If this is a post-revenue company, have revenues been growing steadily or rapidly?
   2. What are the historical financials?
   3. What are revenues projected to be over the next 3 to 5 years.
   4. What are the costs?
   5. Is the company profitable? How profitable?
   6. EBITDA, free cash flows, capital expenditures should be projected over the next 3 to 5 years.
   7. Is this a fast growing company?
   8. What is the eventual scale of the company?

One of the most important elements of evaluating an early stage company is the management team.   In spite of a good plan and roadmap, we need a management team that can execute the plan and drive the growth.   Also important is the value proposition. We have to determine if the products or services offered will only be in a niche market or if they are on a rapid growth trend to a large market. We have to determine how large of a market is necessary for success.   The growth must be profitable and sustainable.

There are many entrepreneurial and early stage companies. The most promising can be identified by critical analysis and evaluation of the 8 areas mentioned above. With business experience and acumen combined with experience in analyzing and evaluating many companies, you will be able to recognize the most promising startups and the potential winners.

From the perspective of the entrepreneurs pitching “Shark Tank” or entrepreneurs and early stage management teams seeking investment from Venture Capitalists, Angel Investors, or Private Equity Groups, it is important to clearly and concisely present their value proposition. They must help the investor understand their venture’s scalability and potential for return in terms of return on investment, amount of return, and time horizon. It is important for the entrepreneur or management team to pitch the venture from an evaluator’s frame of reference with the understanding of what is important and relevant to investors.