The five things we look for in startups

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It has been a busy first half of the year for VentureSouth and the Upstate Carolina Angel Network. Thus far in 2017, our 11 angel investment groups — which now span from Asheville, N.C., to Hilton Head — have invested over $2 million in promising startups in the region, including Upstate companies ActivEd, Atlas Organics, KIYATEC, and Proterra.

As we catch our breath this summer and begin prioritizing our incoming pipeline of candidate companies for the second half of the year, it’s a good time to review and refine our target investment parameters. For aspiring entrepreneurs who might consider seeking early-stage funding, and for potential investors who might be interested in becoming angels, here’s a peek at what we are really seeking as we evaluate startups.

Geography

Like most angel investor groups and venture investors, we are focused on opportunities that are located close to home. We invest locally partly for logistical reasons — we want to be able to easily visit companies for due diligence and board meetings — but also because we want to fill a severe capital gap in our local communities. Not only does entrepreneurial activity offer the opportunity for strong investor returns but also it is the largest driver of job and wealth creation — and we want our investments to generate more economic vitality in communities where we live. As such, we focus on companies located in the Southeast, with the Carolinas as our primary target market. To date, over half our investments have been in South Carolina, and nearly 30 percent are in North Carolina.

Team

In the venture business, investors often claim that the jockey is more important than the horse, meaning the entrepreneur is more important to the success of a startup than the idea or technology itself. We certainly agree — although the team still needs to apply itself in an attractive market — and we assign the highest value to this category in our diligence process. We are seeking entrepreneurs and teams who have a rare combination of insight, credibility, motivation, resilience, and resourcefulness. In the startup world, things often take twice as much money and three times as long as expected, so we want to back teams who can navigate the inevitable ups and downs, extract simplicity from complexity, and create order from chaos. And it should go without saying, but integrity and trust are also crucial and imperative.

Stage

Although we invest very early in the lifecycle of an emerging company, we don’t invest when the would-be business is just an idea or a technology. The entrepreneur must lay the groundwork for building the company by developing and testing the product with real customers and planning a robust business model for getting the product to market. In most cases, we expect to see at least some early revenue to demonstrate that the market will pay for this particular solution to a large and painful problem. Then we can provide our capital to help accelerate the company into the market so it can quickly begin funding itself with cash from customers instead of just investors.

Industry

Given that we have over 220 investors in our angel groups, there’s a high likelihood that at least one of them has relevant industry experience for just about any business that comes our way, so we can consider any type of company for funding if it meets our other criteria. However, the company must have a compelling and defensible competitive advantage, often in the form of intellectual property, and must be solving a large enough problem to create a sizeable business — and quickly.

We are also keenly interested in the company’s exit strategy. Since our investments are private and illiquid, we generally only realize returns when the startup is bought by a larger company — or in rare cases, goes public — so we look for robust mergers and acquisition activity in the sector at attractive revenue multiples, along with exit experience among the management team or board or directors.

Structure

Finally, it is critical that we structure our investments in a way that allows us the potential to generate outsized returns. Given the high failure rate of startups, we must build a portfolio of opportunities that have a chance to generate home-run returns to make up for the inevitable strikeouts. Therefore, we are careful about the price we are willing to pay (usually valuations are in the $1-$4 million range). We also seek preferred equity, which includes several rights and protective provisions for investors. Ultimately, we are seeking opportunities that have the potential to generate a 50 percent rate of return (10 times return in five years, or four times in two years, etc.), so that when bundled with the inevitable losses, we end up with an attractive overall risk-adjusted rate of return.

If you’re an entrepreneur thinking about seeking capital, keep these criteria in mind. And if your company might be a fit, please contact us at venturesouth.vc.

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