This is a pretty old school take on VC evaluation (maybe because he hasn't been a VC for very long?).
Things that matter in today's world:
1. Team (how do they know you/what have you done)
2. Traction
3. Industry (to some degree, more as a blacklist)
That's pretty much it for anything Series A and earlier. If you don't have a very high ranking in one or both of the first two categories, you will not be raising money.
I'd especially second #3, which is a popularity contest. In my experience (raised money twice before, doing it again now), it's basically impossible to raise from VCs/Angels who are not actively looking to invest in your industry already, no matter how good your business is.
Another thing for entrepreneurs to keep in mind is that VC's deal with bigger chunks of money these days. Angels have take on a lot of the early stage risk, so if the process outlined in this article seems overly cautious or insular it's because there's just no need for a VC firm to take on high risk, that should have already been done by FFF and/or angels.
Has anyone gone back and attempted to correlate these scores with ultimate success of the start-ups? Obviously there is the possibility (even probability) of self-fulfilling prophecy, but it would still be interesting to see if the scores have the potential for real predictive value, or are mere rationalization.
This isn't an exact science and still has levels of subjectivity that make it less of a predictive tool and more of a simple litmus test for the fit between the startup and our investment focus. Just because we aren't a fit doesn't mean that a startup will not be successful. Many of the companies that score low will go on to do very well, and conversely there will be some high-scoring startups that don't live up to expectations.
Forgive me, but that seems like an awfully cavalier attitude towards a process that you say you're putting a lot of time and effort into, and on which hinges such large investments and potentially large returns. Hasn't anyone there been curious whether the process actually works and how it could be improved?
Something I have noticed about the VC community is that it is very much dominated by an insular mindset that only permits introductions by companies that are already connected in some way. Companies without these connections don't have a chance, regardless of idea, model, revenues, or earnings.
This article does a good job of confirming this reality, from the initial introduction, to the diligence process. It's unfortunate that capital allocation has turned into a popularity contest.
Not to detract from this article( I don't know if minor self-promotion breaks HN etiquette )but I wrote on this topic recently, with particular emphasis on the AngelList model: http://haploid.com/post/10453313166/the-cool-kids-table
"This article does a good job of confirming this reality, from the initial introduction, to the diligence process. It's unfortunate that capital allocation has turned into a popularity contest."
I think you've arrived at the wrong conclusion, allow me to share an anecdote which illustrates why I think that.
I came to Silicon Valley in the 80's and went to work for Intel. Intel at the time joked they were the biggest semiconductor company in the world because they were losing money less fast than everyone else. I had a freshly minted EE degree and unlike many of my peers I actually had been building microcomputer systems for 6 years already (I soldered together my own Digital Group Z-80 system in high school). As was their policy at the time, Intel started new college grads (they even had a term NCG) on projects which gave them an opportunity to demonstrate their strengths and weaknesses in a relatively 'safe' way. I was handed the 80186 to deal with but there were other, sexier, projects using the 80286 and 80287 at the time. I thought at the time it was 'unfair' and possibly a 'popularity contest' that other engineers had the opportunity to work on those projects in the spotlight when I was 'forced' to work on what was, even then, a 'loser' CPU.
It was later, through a period of some introspection, that I came to realize that it wasn't any of these things, it was simply time. Just like a finance person is loathe to predict a trend based on a small number of data points, or a scientist to come to a conclusion with a small number of samples, engineers and entrepreneurs need 'run time hours' where they have encountered a variety of situations and come away making good and bad decisions and adjusting themselves appropriately. Better test scores, having the 'right' answer now which is validated some time in the future, and being able to reason clearly, are not a substitute for run-time when it comes to evaluating an investment in people.
My conclusion was that what I characterized as a 'popularity contest' was actually the 'understanding my strengths/weaknesses' relative to other folks who might do the same job. The people who had a longer track record were 'lower risk' because the decision maker felt more confident in their evaluation. So lets bring that back to the VC community.
So some times it looks like the VC community is a 'boys club' or a 'walled garden' where if you don't know the right people or go to the right social events you can't 'break in'. And when you do get the introduction but don't get the investment, and that investment goes to someone who has worked with the VC before, it doesn't feel all that great. And yet, from the VC's perspective something completely different is going on.
So a VC or Angel sees your pitch, they pass, but generally they remember that you pitched them something. If the person who did fund it, or if you boot strapped it into existence, and they see that success they get a data point so that the next time they talk to you, rather than being a 'new' thing, you have some run time where they have a data point (your original pitch). So now the discussion can be 'well we passed when you pitched Foobar tell us the story between then and now.' That experience or outcome lets them evaluate your capabilities in a much more objective light. Once you are a 'known' quantity the whole tone of the conversation changes and it becomes relatively easier both to get a meeting and to close a round of funding.
"But it's a chicken and egg conundrum!" is a common retort to this. It does seem that way, but its not. Working in a startup (which is easy to do, just apply) gives you visibility to entrepreneurs who got funding, and depending on scale, to the people who funded them. Excelling in that environment will give you a better understanding of what makes startups successful (or not) and can give you insights into what you would do the same, or differently. While there are always stories of people who turn a dorm room project into a big success, the much more common story is someone who works for an established company and invests in understanding how that works, then works for a smaller company to get a grasp of how all of it fits together, and then perhaps co-founds or bootstraps a company to see what they can do when they have more control over the life and death decisions that startups face every month.
Now if you want to commiserate that it takes 3, 5, or even 10 years of 'minor league' play before someone will trust you with their money in your own venture. I hear ya. I would love to find ways to reliably evaluate the long term success potential of someone with less historical data. Picking entreprenuers who can execute their visions successfully is at least as hard as picking out ideas which will be successful when executed well.
I appreciate your detailed and involved response, and I appreciate your experienced perspective. That said, I'd like to make a few points.
First, I suspect you're assuming I'm new to the industry or that I am working on my first startup. In fact, I have done several, had a number of good exits, and am currently building another profitable, growing business in a large market. I am no stranger to building successful businesses, and I've put in my time on the web developer's equivalent to the 80186 project.
Second, my experience is that success in building businesses in no way translates to the kind of popularity or network that venture capitalists look for. Your claim that simply working in a startup gives one visibility to other entrepreneurs and those who funded them is not something I have seen. I have seen tons of contact with vendors, customers, strategic partners, etc, but never venture capitalists. They simply don't move in the same circles that bootstrapped companies move in.
Mind you, none of this is sour grapes. We're doing quite well growing on the basis of our own cash flow. We are happy to have never diluted ourselves and we are happy to have full control over the board and decision-making. But if we ever got to a point where we would like to accelerate our growth with outside capital, there is a no door open to us in the VC community, because we lack access to that network. Bank loans or traditional boutique private equity firms would be the likely targets of our financing efforts.
Anyway, I enjoyed your story of your time at Intel - it's great to see one of the "fathers" of early microprocessors here on HN. Thanks.
Sorry if our article came off that way, it may not have been very clear from our post, but we look at startups from a number of different sources both in and out of our network.
As the junior guy in a VC firm AngelList applies even more because I don't have an extensive network compared to those that have been a VC for 10+ years. We are active users/big fans of what Naval and Nivi have been doing,and we led a Series A for FlashSoft from an intro on AngelList.
As for your article, I wasn't the cool kid at the table either (I remember sneaking off to play MTG at lunch periods). I am all for democratizing the fundraising process, and I actually think setting up some rules and parameters around how you rank startups helps focus how you look at a company even if it is "hot."
How exactly do you look at startups outside your network? Do you actually take seriously incoming email pitches or cold calls? Do you actively seek out little-known companies that you think you could add value to?
I am a little curious as to how the FlashSoft deal was introduced to you via AngelList, but I understand it's unlikely you'll be able to divulge much, if any, details on it. Even on AngelList, one has to have followers in order to request introductions; yet one has to be visible to get followers, and visibility is determined largely by follower count. I have a difficult time understanding how networks are formed on AngelList without having preexisting networks.
I think that your question will be a good topic for a future blog post, but as a quick answer regarding AngelList.
As an investor you specify which industries/verticals/geographies you are interested in. Their system then emails you with matches to those criteria, and FlashSoft initially came through this way. I then went and did more research on their full-length AngelList profile, shared with the team, did an intro to their CEO Ted, and the process started from there.
We hadn't ever met Ted, and this was their first institutional round as well. We didn't need to have a pre-existing connection or network, rather it was specific to the types of startups we wanted to receive information on. You can see the criteria that we set out here: http://angel.co/thomvest
No, it's not popularity contest. It's a Good Fella business. There's a Godfather sitting in his tower far and away and there's capos and lieutenants (his Good Fellas) who introduce their Good Fellas to Godfather who then invests some money if he likes that Fella. Who cares? Well, Godfathers take other peoples money and promise to invest that money in a best-best way, but they do not - they only invest in Good Fellas.
The reason they do it this way is because it is much easier to evaluate with confidence the people who come through their network. When sizable money is involved it is really the only way to invest. That's the same reason most people would not send a wire to a "long lost Nigerian relative" - the trust in the people on the other side of the table is low.
That's just part of the game. If you want investment from the top tier find a way to get on their radar through their referral network.
Of course the exception to the rule is to build insanely strong traction, revenue and visibility - via either bootstrapping or a handful of angels. Companies like Storm8, 99designs and a few others would fall into this category. The trouble though is that in many competitive markets the odds are against you reaching that position. If a competitor does raise significant resources and uses them to seize advantage in the marketplace your window of opportunity might close real quick.
That's why it is not necessarily a bad thing that it is Good Fella business. Just figure out how to navigate the system and use it to your advantage.
As per my other comment, traction is going to trump all of the strengths you list. As insane as it sounds, this: "solid businesses, great ideas, growing revenues, and strong earnings" is actually going to be a red flag.
VCs want HUGE wins. "Solid" is not what they're going for. They also need to see the opportunity to take over the entire industry. I'm not a B2B guy but in consumer software that means you need to be on track to acquire millions of users.
Having solid revenues, models and a working cash flow system implies a certain amount of lock-in to the way you are doing things now. Are you on an exponential growth trend? If not, then anything standing between you and a pivot (like paying customers) is going to be a hurdle for the investors to get over.
As for the clubbyness -- you're damn right it's too clubby! It's an unfortunate fact that investors come from a pretty insular world. Thankfully if you can show traction, it's going to open a lot of doors that wouldn't open based on who you currently are (or are perceived to be). If you have a rapidly growing base of customers/users, investors will chase you down. If you don't, you need to reevaluate your desire for investment or your focus (traction, traction, traction!)
Actually, we read most of the pitches that come into AngelList (there's an up-front algorithmic filter for junk). There are other investors who browse the incoming firehose as well. If we think something is interesting / likely to be a good match, we email it to investors who follow those markets and locations. If the company gets interest, we broaden the send. Investors follow / take intros as they're interested. Keep in mind that 95%+ of businesses are not fundable by early-stage tech-focused Angels. AngelList is not a circular-reasoning walled garden. Most of the value that we bring investors is surfacing them deals outside of their social networks, and most of the value that we bring startups is finding them investors outside of their social networks. If we didn't do that, we would fail.
It's very much like a dating site. We can't let all of the guys contact all of the girls whenever and however they want. But matches are made all the same.
Things that matter in today's world:
1. Team (how do they know you/what have you done)
2. Traction
3. Industry (to some degree, more as a blacklist)
That's pretty much it for anything Series A and earlier. If you don't have a very high ranking in one or both of the first two categories, you will not be raising money.