5 Criteria to Look at Before Making an Investment Decision:
posted by Netcapital, June 19, 2017
We sat down with Alan Matthews, advisor to Netcapital, angel investor, and Founder of security company Rapid7 to discuss what he considers when evaluating an investment opportunity.
Question: Alan, you must see a lot of deals come across your desk. What factors do you look at before making an investment decision?
Alan: I look at 5 key dimensions of the business: TAM, Technology, Team, Fit, and Exit Strategy.
Question: What is TAM and why is that the first thing that comes to mind?
Alan: TAM refers to the Total Addressable Market. I look at the TAM and the acceleration of the addressable space. What is the market this business is in? Is it a new market? Is it accelerating? Is it an existing market that there is something new to do in? Without a market, you can’t build a company with any real value.
Question: Are there particular characteristics of the market you look for that make it more or less interesting to you?
Alan: Generally speaking, if you have a market that is less than $1B it is very difficult to build and scale a company for exit. It has to be at least $1B, preferably $2B or more and needs to be something that people are focused on or will focus on. It’s very difficult to have a company selling something that’s not in any defined market because no one will follow you. You don’t get any analysts, or anyone knowing what it is, and you’re constantly having to explain yourself. Of course, if you have a new idea which will take time to adopt then it’s a longer road to success, not always a bad thing but not ideal.
Question: What about the technology do you consider?
Alan: With technology it’s one of two things, legacy technology or new technology. I like either. You can buy a legacy company and milk it for the long tail, or invest in it and grow it into a new market. The problem with legacy businesses is they’ve been created, and it’s difficult to do something new. If it’s new, I need to understand if it’s modern and will it last? Do I like the platform it’s driven by? Do I like the way it’s being engineered? Is the engineering team strong or will it have to be re-written again and again, which requires continued investment. How much will that cost and how does that fit into the TAM? Whether it’s legacy or new technology I need to have a clear understanding of the company’s technology and where they’re going with it.
Question: What do you look for in the entrepreneurs you’re investing in?
It is very important to understand the team. Who are these people? Have they worked together before? If you take them into separate rooms and ask them individually what they’re doing will they say the same thing? Do they like each other? Do they work well together? Are they polite and kind to each other? Are they good leaders? Do they know how to manage? Overall, the team has to be strong in their ability to create more than just themselves and dynamically understand what they’re doing and enjoy doing it. It really has to be everyone with linked arms looking outwards. As a company accelerates it places pressure on the team to do more with less and only some, probably small number of them, will get it and move to the next phase of expansion.
Question: How do you identify if someone is a good leader?
Alan: There are only two questions I ask to identify a good leader:
- How do you manage? Any answer is fine as long as it’s not “instinctively”. You need to have a model and you need to have objectives and measure results toward those objectives in concert with the managed employee.
- Who have you created? Give me his or her name and number. I’m going to talk to them. When I do, will they agree with the statement that you created them? How did you get him/her to where he/she wanted to be?
Question: What exactly do you mean by fit, and how does that help you determine if a deal is right for you?
Alan: I like to invest in things that I know, so fit is very important to me. Do I know what these guys are doing or does it just sound good? Can I use my knowledge and what I’ve done to help them? If I don’t know the space I have less capability to evaluate if it’s a good investment. For me, inside sales models and technical innovation are my areas of expertise and tend to be where I focus my investments.
Question: What kind of exit strategy do you typically look for?
You’re either going to IPO and be an industry giant, or you’re going to be bought. 99% of the time you’re going to be bought. So the question is, do you know who is going to be buy you and what you need to look like? Are you going to be the pretty girl at the party? If so, you’ll need the right dress. It’s quite valid to build your company to be acquired by someone specific. Are you talking to the people that might acquire you? Are you using the technology of a particular acquirer? What’s your strategy? A lot of people don’t have a strategy, they just want to grow the company, but you need to have a plan.
As a closing thought on picking investments Alan stated “good judgement comes from experience, which comes from bad judgement”. Picking the right deal is hard, and often takes experience, but establishing a consistent due diligence process is a first step in the right direction.