Prominent investors believe that analyzing and sourcing good deals becomes easier when one is well aware of their preferred sectors and the market opportunity.
In order to reduce the risk and ensure investments in good companies, building one’s own investment thesis becomes crucial to define their own investment approach. The thesis includes important factors such as investment tenure, preferred industries, company stage, and risks among others. This will not only help investors ensure that they are taking the right approach but will also help in keeping ‘conscious biases’ in check while investing.
But once the investment thesis is in place, how can one ensure analyzing the right investment opportunity and most importantly create a steady flow of quality deals?
Govind Shorewala, Founder & Managing Partner, Fairangels.VC, advises investors to select two or three sectors where either one has in-house or advisor-based expertise. He says, “Portfolio-based approach allows for natural diversification — some high-risk-high-return, some core accounts, and some moonshots.”
Accessing and assessing good deals
Even amid the ongoing funding slowdown, private investors are bullish about the India growth story. Rather, industry experts believe that larger opportunities lie in the Indian private markets, and not investing in the market right now may mean a loss of opportunity for investors.
The best way to ensure that quality deals reach you is by broadening your network. Staying connected with angel networks, venture capital funds, accelerators & incubators, crowdfunding platforms, and syndicates will help in discovering new startups. Indirect sources such as following industry blogs, newsletters, top investors, and podcasts among others will also help you learn more about the markets and their players.
“I think a lot of angel investing is about access and for anyone who is starting angel investing today, there is obviously the way where you think of it as an asset class and you invest in platforms like LetsVenture, AngelList and so on and can access many quality deals. But for some others who want to source these deals, work with the entrepreneurs, want to learn and so on, access means everything. For me, my access started through networks at work and networks at places I studied in,” said Abhishek Nag from Luminaire Capital.
Once the deal flow is secured, it is essential to evaluate the ones most suitable for you. While sometimes investments are made based on gut feelings and popular trends, it is best to make learned decisions based on the business model, market size, product, problem statement, and possibly most importantly the team.
In the early stages, there is a high chance that the company is yet to generate revenue or even maybe yet to launch its product in the market. Backing a business at this stage depends a lot on the investor’s perspective of the founder and the team. At this stage, it is crucial to look at not only the product-market fit but also the founder-market fit i.e if they have the required expertise and background in the market, they are operating in.
Simultaneously, Nitin Kamath, Founder and CEO of Zerodha, believes that the best way to evaluate a deal is by speaking with the customers.
“If there is customer love, I think it is worth taking the bet. For instance, if a three-year-old startup doesn’t have customer love then one should not even bother. If you can’t find any customer who loves the product then there is a problem,” he says.
Meanwhile, entrepreneur and investor Kunal Bahl, Co-Founder of Titan Capital, advises to also focus on the business model and its capability to generate unit economics. Even if the business is at a pre-revenue stage, investors need to consider what the unit economics would look like for that particular startup.
“The unit economics of the business will define the soul of the company and determine all kinds of things such as how the entrepreneur thinks about the business, about what he or she actually values in the business, where the company and the team invest its time & bandwidth, what type of experience it provides to its customers, practically everything,” he says.
Understanding deal analysis calculation
An important point to note is that investing in any and every deal will be more harmful and can result in poor returns. The trick here is to find which companies, sectors, and stages work best for your thesis and thus it becomes crucial to understand the logic behind making an investment and analyze the deals accordingly.
If you are working out how the mathematics behind the deals work, Fazlur Shah, Venture Associate in Peaceful Progress Fund, shares an example scenario to help analyze deals better: Let us consider that an angel investor is making $50k investment in a startup. Then how can the investors expect the startup to grow from the seed stage to exit considering the startup success rate is 20% and the expected return on portfolio at least 2X after three years?
How do investors earn from deals?
Investment into the private markets has become an attractive asset class owing to its projected growth opportunity. However, investors need to be aware that not all the companies they invest in would lead to successful returns.
As one continues to analyze and invest in various companies to build the portfolio, investors need to understand the ‘Power Law’ for VC returns, which states that the odds of creating outsized returns for investors increase as they invest in more early-stage companies.
Fazlur Shah explains that the Power Law in venture capital means that few of the portfolios will produce middling outcomes while only a handful would generate the majority of returns.He cites an example considering a VC portfolio that includes 27 companies and the total investment amount across various stages stands at $500 million.
Now if the fund has to show a 3X return of $1.5 billion, he explains that according to the power law, a majority of the total return will be generated by a single portfolio company while three companies together would amount to 70 percent of the total return.
Like everything else, investors too need time to find the best approach and the deals that work for them. As one invests more in startups, one will get a clearer understanding of what works best for them and which sectors or markets they are most interested in.
[Inputs from ‘Basics of Angel Investing, LV Learn’ and Tejas Panchal; Cover image: Unsplash; Infographics: Praveen Gusain]