Why Angel Investors Back Businesses, Not Ideas
“Here’s my advice on moving from idea to startup,” I said.
I was leaving the lunchtime Bible study at Atlanta Tech Village when I heard someone call out, “Hey, Charlie. I have a question.”
It was Rob, a sharp young programmer at a fast-growth startup bitten by the startup bug.
“I’ve got an idea. I think it could be the start of a company, but I don’t know how to get funding. What should I do next?”
That’s the mistake many first-time entrepreneurs make. They think you start with an idea and then raise money.
“You have five doors you need to go through before you’re ready to talk to angel investors. Until you pass through them, you’ll waste a lot of time and come up empty.”
Here are the five doors from idea to startup and how I described them to Rob.
Door 1: The problem - What is the problem that exists in the marketplace apart from your solution? The issue must be clearly identified and defined. Don’t allow your solution to bias the problem definition. The problem existed before you even conceived your idea.
Door 2: The Customer - Who Has the Problem? Somebody has to own it. If there is a problem but no one claims ownership, there is no clear buyer. There is no clear buyer, and no one to talk to who even cares about what you are selling.
Door 3: The Test - Is this a significant enough problem to capture the person’s attention? When you identify the person responsible for the problem, you need to determine if they are willing to resolve it. We all have problems in our lives that we can address if we care enough; however, in many cases, we live with them.
Door 4: The economics - How much will the person pay to solve the problem? Every problem has some level of economics associated with solving it. Here are the two ends of the spectrum. If the problem threatens my life, I’ll spend whatever I can afford to solve it. If it is a problem that causes an inconvenience, I'll spend little to nothing on solving it. As the entrepreneur, you need to be clear on the value of your solution to the prospective buyer. It is not what you think it is worth, but what the buyer is willing to spend.
Door 5: The decision - Based on what you discovered in this investigation, does the economics work? The entrepreneur must ask, “Can I provide the solution to the problem and ultimately build a profitable company?” This is where the rubber meets the road. If you can build a profitable company, go for it. If not, go back to gate one.
These are the doors the entrepreneur must pass through to get to a viable startup. The initial investment in the company must, therefore, come from the entrepreneur.
Investors, particularly angel investors, invest in businesses rather than individual ideas.
This means you must arrive at Door Five before selling stock in your company. The process of getting through these doors is necessary to test your commitment, passion, and understanding of the market you intend to address.
I have been working with early-stage entrepreneurs for over 25 years. I’ve invested in ideas and almost always lost my money. However, when I’ve invested in a business, I’ve almost always made a profit.
As an entrepreneur, you will receive the best value for your business when an investor recognizes it as a viable business, rather than just an idea. As the entrepreneur, this process will be financially and emotionally draining for you. But this is what it means to be an entrepreneur who is investor-ready.
I ended the conversation with Rob by saying, “Focus on defining the problem in the market. In other words, go back to the first door. When you get through door five, you’ll have a business people will be interested in.”