VC secrets: investing in early-stage digital tech with insights from Marc Cohen

12 June 2024
What do investors want? A return on their investment. But what do they look for in a startup? What makes a good founder, and what makes a bad founder? What makes an investor respond to your cold outreach, and what makes an investor invest? In the latest Product Pulse webinar, Marc Cohen, partner at an unbundled vc, and John Radford, LogiNet Systems’ Client Services Director, reveal the answers to these questions.

Key takeaways

  • Success in startups is heavily influenced by luck, making outcomes unpredictable despite best efforts.
  • Initial funding is risky and usually comes from friends and family, followed by pre-seed rounds with angel investors and SEIS funds.
  • Investors prioritise solutions with high potential returns and alignment with their investment thesis.
  • Strong sales skills are essential for entrepreneurs to secure investment, attract customers, and hire top talent.
  • Building networks takes time, but respectful and clear cold outreach is acceptable if warm introductions are unavailable.
  • Proof of market demand and problem significance is crucial for attracting investors.
  • MVPs are critical for testing demand and validating startup ideas, with persistence and adaptability being key.
  • Early-stage startups typically give up 15-25% equity per funding round, requiring a balance between brand building and scalability.

Luck and success in entrepreneurship

Luck plays a significant role in startup success because, in practice, nobody knows who will succeed. Everyone's doing their best, and the founders are doing their best to pick the right thing to focus on and to build it as well as they possibly can.
The investors are doing their best to pick the things they think have the best chance of succeeding. But nobody knows who will be winners and losers, as a huge amount of luck is still involved in determining the actual outcomes.

Investing in startups in the UK, including funding rounds and valuations

The typical stages of investing in the UK begin with "friends and family rounds": make sure that those people go in with their eyes wide open, knowing that this is a risky game. You don't want to lose those sorts of friends and family at the end of it, along with all those relationships.
The next stage is usually the pre-seed funding round, which can be a sort of angel investing round. There are quite a few VCs that specialise in that, but there are also many SEIS funds. When the funding market is more challenging, it’s important to have a solid business plan and be prepared for challenges at this level.

Investment strategies and evaluating startup potential

Investors prioritise ranking games and aligning with their thesis when evaluating startups. They seek proof points to reduce risk and maximise potential returns: look for solutions with the potential for 100x returns, but 10-20x returns are still possible with a good outcome.
There are multiple factors to consider when making a decision. Founders must solve an important problem for clients, with a large enough market size and client care, to attract investors. Additionally, it’s also a question of whether you fit their thesis, for where they say they're going to invest their funds. If they don't invest at pre-seed, for example, you're not going to get anywhere.

The importance of sales skills

One of the important skills is the ability to sell. Investors are attempting to ascertain your skill set, which they can only do by engaging in a conversation with you. One of the most crucial skills is the ability to sell, which encompasses the ability to sell to investors, to sell the product, and to hire the best people.
In industries like this, your success is largely contingent on your ability to sell. Can you do business development? Can you bring in clients? Selling skills are crucial for success.

Cold outreach strategies for investors

It is important to note that building up networks and reputation is not an instant thing. However, if you do, then you should try to get as many warm intros as possible. And if you can't, it is perfectly fine to reach out cold.
It’s important to be direct and clear about the purpose of the call and respectful in cold outreach, building relationships before asking for a call.

Validating startup ideas through market demand and product-market fit

Investors require evidence that the problem being solved is important and that there is demand for the product. This can be demonstrated through various methods, including numbers (such as growing sales), enterprise (customer feedback), and market research (customer needs).
Market size potential is significant if the startup can deliver high-quality service at a competitive price point. Investors want to see evidence of a tech partner's ability to deliver a product before investing. It is crucial to collaborate with a team that is aligned with the founder's objectives.

Minimum viable products (MVPs) in product development

There are successful startups that prioritise speed over perfection. MVPs (minimum viable products) are important in testing demand and validating ideas.
Airbnb's founders launched their product three times before gaining traction, highlighting the importance of persistence and adapting to changing circumstances in entrepreneurship.

Investing in startups: valuations

The valuation range for early-stage startups is wide (15-25% of equity). Each round of funding may result in dilution, particularly in capital-intensive industries. Founders must strike a balance between building a strong brand and adding scalable features to maintain defensibility.
A successful startup requires a deep understanding of the domain and personal experience, as well as the ability to identify a unique problem and differentiate the startup from competitors through a strong brand.

Q&A with Marc Cohen

1. How do you make judgements about whether a founder is the 'right' person?

  • I would be interested to hear a video pitch. I believe it is challenging to assess a founder's suitability from a pitch deck. You can list some skills and ascertain whether they are capable of building a pitch deck.
  • Every investor has a different set of skills they're looking for, and they can directly ask about them or try to find out more in conversation. It's not just what you do, it's also how you talk about it.
  • First time on this, I'm trying to figure out whether they possess the requisite skills. Second- or third-time founders may be more likely to have the necessary skills, as they have gained some experience. However, the fundamental question is whether they possess the requisite skills.

2. What's your feeling on valuations at the moment? What does 'realistic' currently look like with a pre-seed VC if you are pre-product/pre-revenue?

  • A difficult question to answer. It depends on the amount of capital raised and the strength of the founder's skills, for instance, in the field of AI, which is currently a highly sought-after area. However, if there is a promising market with strong founders, there are few people in the world who can build such products, my objective is to gain a foothold in one of these areas.
  • Valuation is a challenging issue for founders. The most effective approach is to consult with other founders who have recently completed fundraising or have just done so.

3. What are your thoughts on AI wrapper products from an investment opportunity perspective?

  • I believe there is potential for profitability in the short term, but it will be challenging to build a sustainable business. It’s going to be easy for people to ask questions themselves; ChatGPT 7 or 8 will just be able to do it for you.
  • When you're building the application layer on top of these products, it may have enough of your expertise wrapped into it. However, it is not something that can be achieved directly.

4. What is your advice for founders on approaching defensibility questions during pre-seed rounds?

  • Different investors have different perspectives. Ideally, you build something with market-appropriate content that only you, as the expert, can make.
  • For example, there's Zoom, which was an extremely successful business during the pandemic and still has high appreciation today. At first glance, it might not have seemed like it would be that successful because it's free. However, on day one, no one could have predicted what Zoom would be like.

5. Is domain expertise a "must-have" criterion for you to invest during pre-seed rounds?

  • It is essential to determine this for yourself before seeking investment, as it is a key factor in convincing potential investors. You must be able to demonstrate why you believe it is the case and be able to convince me.

6. At what stage does the brand start to become important?

  • I believe that a company's brand is always being built, regardless of whether or not they are working with an agency. The company's brand ties back into the sales piece.
  • The importance of the business will vary, and this will determine how much time should be dedicated to it. How much difference do you think it makes?

7. Would you include a valuation in your deck, or just the amount you're raising?

  • One challenge with valuations is that founders naturally want them to be as high as possible. This is understandable, but it can also lead to difficulties in raising money if the valuation is too high.
  • It's important to strike a balance between ambition and realism.

8. Regarding the number of years of projections, it's important to note that early-stage figures can be estimates even after 12 months.

  • Everyone knows that estimates are based on informed guesses. For example, it is challenging to predict whether revenue will reach 100 billion in two years. However, it is important to demonstrate ambition. Even if it is not always realistic to expect this to happen, it is important to show a clear path to the desired outcome. Without a clear vision of growth, it is unlikely that the desired outcome will be achieved.

The final takeaway from Marc

It can be really challenging to build a business and raise funds. There is a high level of uncertainty involved, but without people willing to take risks, there will be no investment opportunities.

Watch the full webinar!

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John Radford
Client Services Director UK