Angel Investing: No Revenue, No Metrics, No Magic Formula

As First Round Capital managing partner Rob Hayes met with the founders of another potentially promising startup earlier this week, he couldn’t help but fixate on the team’s crowded roster. The fledgling company had barely been in existence long enough to print a batch of business cards, yet it had already collected a CEO, COO, CFO, vice president of marketing, vice president of sales and two engineers.

For Hayes, whose company saw 700 investment opportunities last quarter and funded 12, this glut of executives did not bode well. “You know, who is going to do the work?” he asked himself. The startup ended up on Hayes’ “No” pile.

Hayes recounted the story today during Orrick’s Total Access panel at the Merchant’s Exchange in downtown San Francisco. And while the event was titled “How to Pick Your Angels,” much of the chatter was devoted to how angels pick you.

Bring users, buzz and money

To the displeasure and frustration of many, early-stage investing is more art than science. The companies are barely companies: They haven’t shown revenue or even have a revenue model in mind, so there are no metrics. Much of the decision-making process, for both the investor and the founder, is based on instinct and past experience.

“It’s a probability game. I bet we all get 5, 10, 20 –- maybe even 50 times the amount of pitches than we could ever sit down with,” said Mitchell Kapor, best knows as the designer of Lotus 1-2-3, who has come up with his own filter for deciding which pitch meetings he will take.

With Silicon Valley booming once again, one of the biggest debates in early-stage investing circles revolves around the importance of an actual product and performance versus talent and ideas.

Kapor falls firmly on the “show your work” said of the debate. He said he needs some tangible proof (money, users and buzz, or both) of a product or company’s potential before he takes a meeting. If the product a company is pitching is supposed to produce revenue, he expects the startup to have a little bit of money to show for its time. “That’s because even very small amounts of money, virtually none, with some time, you can get your concept to the point [where] you can demonstrate what its actually doing,” he said.

Cash isn’t his only metric. Social proof, like hearing about a new app by people he trusts or reading positive chatter on sites like AngelList works too. But he added, “If it’s just ‘I organized a team of people and this is my concept — and god forbid its another Groupon clone — there’s just very little interest.”

Hayes isn’t as hung up on the product a team is pitching, largely because virtually all of the concepts he’s invested in at an early stage are scrapped before going to market. The product you walk in the door with is usually not the products you end up scaling with, he said. What he’s looking for is simple: “Kick-ass entrepreneurs and big-ass markets.”

While Hayes stresses the fundamentals of the team and their potential market above all else, Jeff Clavier, founder and managing partner of SoftTech VC, said “Even the great team and a potential market can come up with a pretty s***** product.” He needs to know that the startup has some business sense, that “you’ve figured out a few things like customer acquisition, customer retention, customer referrals, which will sort of give you a way to acquire your users keep them around.”

If at first you don’t succeed

And what if you’re a startup whose already shopped yourself around town and isn’t getting anywhere? The angels all agree that quitting and starting over can be a gift. If you have the right team, there is always a second and third chance in Silicon Valley.

Said AngelList founder and investor NavalRavikant: “If you have a fundable company for the environment you will get funded. But if you find you aren’t getting funded, you should not go out there and sell harder,” he said.

Kapor said he has invested in at least three Y Combinator teams that he initially rejected. While he felt their first tries didn’t work, he liked the teams and thought they had potential. “I said if you wind up dong something different, please come back,” he said. And it was the second time that clicked.