How to Assess the True Quality of a Startup

Startup Wall with text "We like you too"
January 19, 2023
Perspectives
Written by
Joachim Schelde
Senior Investment Associate

Entrepreneurs would often ask for guidance on where to focus their efforts. One can’t give company-specific advice without knowing the business inside-out, but these five pillars of strength are applicable to determining company success in many cases.

In any given industry, investors will look for:

  1. An A-star founder/management team.
  2. A unique product offering.
  3. High customer value-add.
  4. Great scalability.
  5. A strong proof of business model/commercial traction.

Everything else, whether the market is $100bn or $500m and grows 20% versus 8%, or if the technology is disruptive, are not key elements on a stand-alone basis.

For any startup investor, excluding mega-funds that need to spray-and-pay invest because of their fund economics, the key to good returns is proper downside protection and a good upside for when things go well.

Everything else, whether the market is $100bn or $500m and grows 20% versus 8%, or if the technology is disruptive, are not key elements on a stand-alone basis.

For any startup investor, excluding mega-funds that need to spray-and-pay invest because of their fund economics, the key to good returns is proper downside protection and a good upside for when things go well.

1. Team

People are the number one success criteria in any company; it is the fundament to which the other four pillars can be brought to life.

In a screening process, investors look for experienced founder/management teams, preferably 2–3 founders, with strong market insights and complementary skill sets. First-time founders are relevant too, but these may be tested more intensively in areas such as organizational scaling, customer insights, etc.

Great visionaries who know how to get there and demonstrate strong dedication, ethics, and likeability are particularly exciting.
And to have founders who are very capital efficient is something that’s become even more important for investors in the current market. Often, however, it comes down to fundamental social intrinsics; do both parties like each other, are the founders good human beings, are they able to execute/hire talent, etc.

A tip for founders:

Early-stage tech startups that lack the capacity or brand recognition to hire A-star team members could form a warrant pool of 5-10% to attract high-performers. Likewise, an Advisory Board could be formed of market/technology experts and serial entrepreneurs. But when offering equity then, remember to have a proper cliff and vesting period agreed upon.

People are the number one success criteria in any company; it is the fundament to which the other four pillars can be brought to life.

2. Unique Product

The following four pillars weigh equally in importance. A unique product is not necessarily something totally new to the world but perhaps an improved approach to an important problem enabled by technology. It can also be a team with unique capabilities in an otherwise red ocean market

Different investors have different product preferences; it’s a good idea for founders to research their investors before reaching out. At Scale Capital, we generally prefer IP-driven companies where we have defendability in the technology or platform businesses with strong network effects. Obviously, we are also intrigued by products that are simply 10x better than existing solutions, whether IP-driven or not.

A tip for founders:

In the pitch deck, showcase how your startup differentiates from the competition and avoid just about mapping it on a two axes system. Instead, dig into specifics on what sets you apart, whether it’s the technology stack, the network effects, the team capabilities, or something else. It can also be smart to show your weaknesses and be honest and transparent about your biggest risks – investors will then feel much more comfortable.

3. High Customer Value-Add

Having a unique product doesn’t matter much if it doesn’t add value to customers. Hence, investors will look for 10x improvements/customer value-add in companies, which can be measured in a variety of ways.

Founders would want to include customer cases where they show how they helped their customers improve, whether related to sales, marketing, procurement, employee well-being, or something else. It is also a good idea to include demonstrable improvements, such as x times more website traffic, x times better conversion rates, x times better business insights, etc.

A tip for founders:

Stay in continuous dialogue with your customers and ensure that you understand your cohort churn/retention metrics and their causes. Listen to feedback and continuously build out your product to meet core needs. But focus on what’s important; customers don’t want amazing new features; they need real solutions to their problems.

A unique product doesn’t matter much if it doesn’t add value to customers.

4. Great Scalability

When it comes to scalability, two elements are crucial – the scalability of the business model and the scalability of the go-to-market strategy. Those two go hand-in-hand.

Certain clues can tell whether or not a business model is scalable. Those include the nature of the revenue streams (recurring revenue versus one-time off sales), high gross margins, and a high lifetime value (LTV) to customer acquisition cost (CAC) ratio, just to mention a few.

For go-to-market strategies, investors mainly look into churn/retention/renewal rates to assess whether the founders actually have a product-market fit. Next, investors would likely consider the sales process and dig into the average sales cycle, conversion rates, onboarding time, CAC payback time, etc., to measure the efficiency of the go-to-market strategy.

A tip for founders:

Include your current go-to-market and expansion strategies in your pitch deck/storyline — and show how they fit into your product roadmap.

5. Commercial Traction

Finally, some investors would like to see a strong proof of business model, meaning a solid customer base and good revenue levels with high growth numbers. Founders are often challenged on their average deal size and monetization opportunities per customer, as well as the geographical dispersion of their customers. Especially the latter can be a good clue for internationalization, as you can never be sure to what degree the product is truly applicable in other countries before you have actually sold it there.

The commercial traction is then often benchmarked to comparable competitors (if any) in terms of capital raised, number of team members, year founded, etc.

A tip for founders:

Calculate unit economics that are fully loaded (i.e., no ugly surprises) and specify your revenue streams. It’s also advisable not to calculate ARR by simply multiplying current MRR levels with 12 unless your product has only monthly subscriptions; often, it’s a mix of yearly and monthly subscriptions, and then you need to specify ARR and MRR independently.

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Although the framework is rather simplistic and may not fit all types of companies and industries (especially deep tech and life science), it does however provide proper guidance for most tech founders and investors in what to look for and prioritize.

The five pillars of strength constitute a subtle approach to startup investing in which the investor targets fundamentally strong companies. Accordingly, founders can enhance their fundraising success by checking off each of the five pillars.

About
Joachim Schelde
Joachim is a Senior Investment Associate at Scale Capital where he is responsible for the origination and execution of investment opportunities and for building partnerships between Scale Capital and relevant investors, advisors, and industry experts.
Scale Capital
Scale Capital is a Danish venture fund from 2012 investing in Nordic B2B tech startups at Seed/Series A and helping them win in the US.