What angel investors look for in startups: A founders guide

I have invested in a number of startups over the last decade, specifically in the healthcare and education sectors. I think it’s important to invest in sectors that you know. Some may disagree with that statement, and what this boils down to is risk tolerance. I try to stick with what I know unless something is a sure thing. Like anything in life, sure things are exceedingly rare.

Angel investors like me play a crucial role especially in the initial stages of a startup's journey, providing not only capital but often mentorship and valuable business connections. I consider myself to be an engaged investor in that with my investment comes my experience and mentorship. Unlike venture capitalists, who generally invest larger sums at later stages, investors like me typically invest our own money in early-stage startups in exchange for equity.

To understand how to attract angel investment, I will outline many of the factors I consider when evaluating a startup. These factors range from the business idea and team to market potential and financial prospects.

1. The Founding Team

It is no coincidence that I have put the founding team as #1. The startup's founding team is arguably the most critical factor for me. You can have the most marketable product or service, but if you have a weak team, then that product or service will struggle to realize it’s potential. A strong, well rounded team with the right mix of skills, experience, and determination who can pivot or adapt as needed is a recipe for success as far as I am concerned.

What I look for in a founding team is:

• Experience: Founders who have relevant industry experience or a successful track record of entrepreneurship are more attractive. I want to know that the team can execute on their vision.
• Passion Commitment and Respect: A passionate, driven team who work well together is likely to persevere through the inevitable challenges of building a startup.
• Complementary skills: Ideally, the founding team should cover all essential areas (technical, business development, marketing, and operations), demonstrating their ability to manage all aspects of the business.

2. The Idea and Its Innovation Potential

Personally, I am drawn to innovative and unique ideas that can disrupt the market. Healthcare is full of products and service that are market disruptors which is why I am so attracted to this sector. For me, the idea should address a real problem or fill a gap in the market.

I will look at:

• What problem is the startup solving? Startups that tackle significant and painful problems are more likely to succeed.
• Is the solution unique? I prefer startups with a unique selling proposition (USP), something that differentiates them from existing competitors.
• Innovation potential: The more innovative the idea, the more compelling it becomes to me, especially if it is difficult for competitors to replicate.

3. Market Opportunity

I want to ensure that the startup is targeting a large and growing market. Even with a talented team and product, the startup will struggle if the market is not big enough.

Key factors to examine include:

• Market size: Is there a large enough market for the product or service? I typically prefer industries with substantial room for growth like healthcare and education.  
• Scalability: Can the startup's business model scale? I want assurance that the company can grow exponentially as it acquires more customers without dramatically increasing costs.
• Market trends: Startups that align themselves with current and future market trends (such as sustainability, AI, or digital transformation) are more likely to gain traction.

4. Business Model

A well-thought-out business model gives me confidence that the startup can generate revenue and grow sustainably.

Key questions I ask in this area include:

• How will the startup make money? The revenue model, whether through subscriptions, sales, licensing, or another method, needs to be clearly defined.
• Profit margins: What are the projected profit margins? I want to know if the business can generate healthy margins as it scales.
• Customer acquisition strategy: How will the company attract and retain customers? Having a realistic marketing and sales plan helps convince me that the business model is sound.

5. Traction and Proof of Concept

One of the most reassuring signs for me as an investor is early traction, which serves as validation that the product or service has demand.

Traction could include:

• Customer base: Even a small but engaged customer base shows that the startup's offering has value.
• Partnerships: Strategic alliances or partnerships with key players in the industry indicate potential for growth.
• Revenue or user growth: Rapid growth, whether in revenue, users, or engagement, is a positive signal.

While some startups may not have significant revenue at the time of seeking angel investment, any indicator of progress, like a growing customer base or product development milestone, I view favorably.

6. Risk and Reward Balance

Since investing is inherently risky, I seek to balance the potential rewards with the risks involved.

Here I consider:

• Competition: I like to know the competitive landscape. Startups facing heavy competition or lacking a competitive edge I shy away from.
• Barriers to entry: Startups that can create barriers to entry, such as proprietary technology, patents, or strong brand recognition are attractive and seen as lower-risk investments.
• Exit strategy: I want to know how I will get a return on my investment (ROI). Whether through acquisition, going public, or another exit strategy, startups need to articulate how they plan to offer an eventual payoff for early investors like me.

7. Valuation and Equity Offered

I pay close attention at the startup's valuation and how much equity is being offered in exchange for their investment. The valuation should be reasonable and in line with the startup's stage and market.

Overvaluation can be a red flag to an investor like me, indicating that the founders have unrealistic expectations or are inexperienced. Conversely, undervaluing the business may raise concerns about the founders' confidence or understanding of the market.

I also assess the equity distribution among the founders and early employees. If too much equity has already been given away in earlier rounds or to early employees, it could limit the upside for both the founders and future investors.

8. Financials and Projections

While early-stage startups may not have extensive financial histories, I will scrutinize the company’s current financial status and future projections.

I look at:

• Burn rate: How fast is the startup spending money? A high burn rate without corresponding revenue growth can be a red flag.
• Funding needs: How much money is the startup asking for, and how will it be used? Clear plans for my investment, such as expanding the team, marketing, or product development, are essential.
• Revenue projections: Are the financial projections realistic? While I appreciate optimistic projections, I do want them to be grounded in reality.

9. Alignment of Interests

Finally, my interests have to align with the founders’ long-term vision.

Here I look for startups where:

• The founders are invested: Founders who have personally invested time, money, or resources into the startup demonstrate commitment.
• Shared vision: The startup’s goals, values, and exit strategy align with my expectations. For instance, if I seek a quick exit, which for me would be less than 3 years I will avoid startups focused on long term growth over immediate returns.

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Attracting investment from my experience is not just about having a great idea. It is about building a compelling story around the team, market potential, business model, and financial outlook. I am looking for startups that offer the right balance of risk and reward, backed by a capable and committed team.

For founders, understanding these key evaluation factors can significantly increase their chances of securing early stage funding and launching their business on a path to success.