There are many formulas for angel investing. This one is very similar to other ones you’ve seen. The only difference is that I came up with a way for each of the 4 pillars to start with the letter T so they are easier to remember.
This is not a complete guide to Angel Investing. There’s a lot more to it. But these 4 things I think are most important.
This is very similar to Jason Calacanis’ 4 questions outlined in his book Angel, which I loved and highly recommend. Although it’s not perfect so I’d combine it with other research.
1. TAM (Total Addressable Market)
There are lots of ways to approach this pillar and there are some inherent components. First, the product has to be great in order to have a large addressable market. Ideally it’s highly innovative, disruptive, or game-changing. Second, the market has to be huge.
It’s important to note that the market doesn’t have to exist yet. You can be creating a new market or adding on to existing market. Or you can just be disrupting an existing market. Either way, the problem you’re solving has to be huge.
You’ll hear different opinions about a huge market. On the low end it’s $1B. On the high end it’s $1T. Personally, I’m only interested in companies that have a TAM of over $100B. My preference though are trillion dollar industries.
Trillion dollar industries are the space where you can get a 100X or 1000X return on your investment. Many of these investments will be moonshot opportunities. Binary. They either kill it and change the world or they completely fail (most fail). That’s why you need to carefully pick up to 50 bets and then there’s a good chance one will hit the moon while the rest fail.
Here’s something else I think is important with TAM. Founders will try to calculate the largest possible TAM in their investor presentations. Here are some tips to cut through the noise and figure out what the real TAM is.
The entire industry in which they play is not the TAM, but many investors and founders will use that as TAM. That’s misleading because it can make it sound like a company has a lot more sales potential than it really does.
Example: Let’s say travel accommodation is a $600B industry. And let’s say I’m starting a hotel price comparison website like Trivago. The TAM for Trivago is not $600B. That’s all hotels, which includes the revenue of the hotels and vacation rentals. Hotels get most of that money. The true TAM for Trivago that I would look at is the total amount of commissions hotels will pay a referral source. That TAM is probably more like 10% of the total hotel TAM.
True TAM in my opinion is total number of potential customers * annual revenue per customer. That is usually much, much smaller than the TAM of a total category.
When I’m evaluating a business, I ask myself whether I believe this team has the right combination of personality, skills, intelligence, and drive to take this business all the way. All… the… way.
First, keyword, “TEAM.” If there’s only one person in the company, it’s a little early for me. I like for there to be at least 2 cofounders. One person just isn’t enough to get a business off the ground. Also, one of the founders have to be technical and can code or do the engineering required themselves. The other can be good at operations and execution of other things. I don’t like teams that are outsourcing engineering. In tech, that is a core function and needs to be in house.
Second, the technical team members need to have a background in the field in which the company plays. For example, if it’s a software business heavily dependent on AI, I want that cofounder to have a computer science degree and many years of programming experience with AI. If it’s, say, a hardware business, I want one of the founders to be an electrical engineer or whatever is needed to be expert in that hardware. I also prefer founders who came out of an industry frustrated with legacy solutions and see a way to disrupt it.
Third, the team members need to be at a stage in their lives where they can dedicate the next 5-10 years to this venture. By stage, I don’t mean age. I mean do they have the energy, resources, and time to be fully dedicated? That can be at any age. This can’t be a side gig or a 9-6. They have to live and breath it every moment. I can usually determine this by the way they talk about the business. I can sense when someone has fire in the gut just by the energy and passion they exude when discussing their business.
Fourth, I like to invest in founders that have the rare combination of humility and ambition. People who are arrogant can succeed, but they also can be closed minded because they think they know it all. I like self-aware founders who know there is still so much for them to learn and are open-minded. And who know their strengths and where they need to hire to fill in the gaps.
Fifth, do they know their business down cold? Every metric across every aspect of the business. This can get hard once you have hundreds of people. But early on, they should know everything off the top of their heads. This shows that the founders are detail oriented, meticulous, they are doers, and they really get into the weeds. No professional managers in start ups. Everyone is either coding / building or selling. No bosses, supervisors, or middle managers are needed at this stage.
Six, resourceful and scrappy. In order to get a tech start up off the ground, you have to overcome near impossible and insurmountable odds. As Elon Musk said, being an entrepreneur is “like eating glass and staring into the abyss of death.” So in order for a founder to succeed, they have to be able to do more with less. This involves being very resourceful and scrappy, finding ways to get things done with limited resources, time, and money. And being able to break through walls and jump hurdles that would trip up the average person. And not ever getting discouraged when things don’t go smoothly, because they won’t. It’s always a bumpy ride… always.
Seven, I like missionary versus mercenary founders. I like founders that believe they are going to change the world and aren’t just in it for the money or being opportunistic. Mercenaries can be successful, but missionaries change the world. And only businesses that change the world provide the outsized returns an angel investor needs to make it worth the risk.
The market has to be ready for this type of product or service. And the technology has to be there. Timing is a primary driver of a business’ success.
You’ll want to ask questions like, why hasn’t this been done before? And why is now the right time? What’s the perfect storm of market and technological readiness that makes now the right time?
Here’s an example: Netflix could never have succeed with its video streaming business ten years ago. The IT infrastructure and bandwidth just weren’t there. But now they are and that’s why almost no one gets their DVDs mailed anymore and their streaming videos are a staple in every home.
The market was not ready for messengers like Snap, Instagram, and WhatsApp 10-15 years ago. The generation that adopted those technologies were in diapers at that time. The adults 10-15 years ago were fine with email and not likely to adopt messengers. Now you have every millennial and teenager communicating almost exclusively through messengers.
In hardware, it’s often the case that a core technology required to pull it off simply didn’t exist until fairly recently, like 3D printing. Now that you can 3D print components, XYZ business makes sense, where it wouldn’t have 10 years ago.
Another example can be regulatory. For example, the FCC just made military grade high resolution radar frequencies available to private businesses. In the past, it was only allowed to be used by the military. A business making high def radar for self driving cars could not have existed 10 years ago. Also, there were no self-driving cars 10 years ago.
For me to invest, the company has to have some early traction. I don’t invest in ideas, PowerPoints or business plans. I invest in companies that have a working prototype and early customers or users.
This is what Angel Investor Jason Calacanis calls the “Goldilocks Zone.” Just before they’ve started to take off, but after they’ve gotten a product to market. Not too hot, not too cold.
For B2B businesses, I look for a product in the market with paying beta customers. And there needs to be metrics on how much money it saved or made the customers. If they haven’t proven that the product adds value, it’s too early for me.
There’s a concept called “Product Market Fit” that is commonly used in Silicon Valley. It means customers love it so much they’d be angry if it went away. And it solves a pain so acute, that they’re willing to bear with the bugs and issues with an early product. And they are willing to pay money for it.
Basically, from a product standpoint, you have to have found your footing, have a product that meets the needs of your customers, and have reference customers and performance metrics to demonstrate the value your product provides.
We’re not talking a lot of customers here. For a large sale, it would be 5-10 fortune 500 companies. For a lower cost product, I’d want to see several hundred businesses using it. In today’s low cost start up environment, scrappy and resourceful founders should be able to drum up this early business themselves without much capital. Otherwise they probably don’t have the scrappy qualities I’d look for in a founding team.
For consumer, I like to see thousands of paying customers or tens of thousands of users if the product is free. And I like to see retention and engagement metrics. If they don’t have any metrics on things like cost to acquire a customer (CAC), retention rates, engagement rates, and revenue per customer (if relevant), then they are too early and not in the Goldilocks Zone.
And again, in today’s low cost start up environment, scrappy and resourceful founders should be able to generate thousands of customers themselves without much capital. Otherwise they probably don’t have the qualities I’d look for in a founding team like I said above.
There are some exceptions I will make on the paying customers front. For software, it’s a must. For physical products, whether it’s agricultural drones, delivery robots, synthetic food, satellite technology, there is usually a longer time-frame for being able to have a product that is customer ready. For these businesses I look for 3 criteria. 1) They have to have a working proof of concept that just requires some refining to get to market and 2) if they do get to market, the opportunity is absolutely game changing to the trillion dollar scale and 3) LOIs or pilot customers lined up for when the tech is really ready. Lining up pilot customers validates that the product or technology is truly novel.
Hardware and physical world businesses are much more binary than software. With software you can be more nimble, pivot, and solve problems much more quickly. With hardware, it either works or it doesn’t. So, to overcome the low likelihood of success, the upside has to be huge.
For example, I recently invested in a 3D metal printing business. They have all the things I want to see: engineers as the founders, scrappy, smart, working prototype, ambitious, yet humble. They have some technical hurdles to overcome that will take a while to work out. But they should work in theory. If it works out, it’s world changing. Metal 3D printing will be 10X cheaper, faster, and more reliable than ever before. And they’ll have patents and IP to protect it.
Every manufacturer in the world from auto, space, electronics, and computing will want to become a customer. It’s a truly $1T category and the company could quickly become a $100B business.
This is what we call a moonshot opportunity. But the opportunity is so big, and the tech is far enough along that it’s not just a concept, that I think it’s worth making a bet because of the outsized upside if it works.
Also, while they don’t have paying customers, they do have pilot clients lined up waiting to do beta tests when they are ready. That’s a really good sign and I’d want to at least have that for this type of start up.