Cofounding investors series 2.4
2. Startup cofounding teams business set-up
In the cofounding investors series we look together on how to evaluate a startup cofounding team. How to identify any possible red flags and take care of the orange flags (mitigate the risks that do not present a deal breaker and you can take care of).
The logical place to start is the team’s business set up.
Lets take the pointers one by one:
A. does the team have the competences and experience to deliver the next milestones in their business plan (for which they are asking you to invest)?
This is a relatively straightforward assessment if the business is sufficiently mature (having had validated and confirmed business plan, market validation, and having traction - i.e. the need for (immediate) pivot is limited).
If the business is sufficiently mature - you make an inventory of the required competencies and experience (you might include required assets and network access too if you want to go more detailed) - and check for what the cofounding team has. For the gaps - you need to assess if the company can close the gaps (outsourcing, buying, acquiring otherwise).
If the business is not sufficiently mature (i.e. pivot likely), this is not going to be so useful for you. In this case, move to the next pointer.
B. how is the team’s delivery and execution capability?
Ask for previous references, check those references (i.e. yes, pick up the phone and talk to them), and if you do have the time - observe the team for a reasonable period to assess how they deliver and execute in the current project.
“As Michael Sidler of Redalpine in one interview mentioned: “ There is nothing more valuable than observing a team over time. Meet with them for a coffee. Follow them. Observe how they executed and delivered. Ask difficult questions.” The shorter dating period you have, the more you need to look at their past performance when it comes to execution skills.”
C. did the team define the required commitment and roles for each of the cofounders?
This is the one point which is very often misunderstood and misinterpreted (mainly but founders, but also sometimes by investors). Why would you need that?
Commitment: you can get a check on how realistic / experienced the founders are from this estimate. You can also get very important information on the likely stability of the cofounding team. Founders with different commitment (especially the early stage full time part time combination) need to have corresponding team set up for this to work (i.e. proportionate reflection of the commitment in the cap table). If the team did not discuss and reflect their commitment in their equity allocation - it could be either inexperience (which is something you might be willing to risk) OR - inability or unwillingness to have difficult conversations - which is something that indicates dysfunctional team. The reasons might be various, but the conclusion is critical - if the team is not able to have difficult conversations - you do not want to bet your money on them. They will not be able to have other difficult business conversations or make difficult business decisions. And you need them to be able to do exactly that.
Cofounder roles (and performance milestones): really? Do we need that? They are not employees, they are founders. Yes. And - you do want the founding team to have talked about it and have it defined.
Why? It is true that in the beginning the team needs flexibility over specialisation. However, for many startup teams - frequent mistakes include shared roles, unclear allocation of responsibilities and accountability and multiplication of effort (leading to inefficiencies). And - hopefully the founders competencies are sufficiently different to be able to define their role outline from the beginning. As for the performance milestones - that is where there is usually the most resistance - some logical (too early stage of the business, pivots ahead, difficult to define), some emotional (i am a founder, i should not have to have them).
Depending on the maturity of your team and their business plan - you have higher or lower exposure to that risk - but you cannot eliminate it. The risk is called non-performing founder. You don't want them. They are expensive. Can cause a team break up. Have a very bad impact on team’s motivation and attitude. And they do exist. And you have a very difficult time dealing with them if you have not defined what performance is.
D. does the team equity split seem fair
In my experience, most of the cofounder breakups and wars could be traced - directly or indirectly - to the category of unfair - or perceived unfair - equity splits. There are some great articles on equitable not equaling equal. So I will not get into the details on how to get closest to fair equity splits here. If you like - check here - Jana’s blog post.
What is important for your due diligence of the startups cofounding team is whether the equity split seems fair to you. Does it reflect the cofounders commitment? Experience? Reputation? The assets they bring? Roles? And: is it perceived as fair by the founders?
The biggest flag? I am not saying that equal equity splits are never the right solution (even though I am still yet to be convinced of their benefits) one thing you need to make sure is, that the reason the team chose equal equity split is NOT the avoidance of difficult conversations. The team needs to be able to discuss sensitive topics - and equity conversation is definitely one of those. It does tell you a great deal about the team not only how they split the equity, but also how they arrived at their splits. Ask them. And listen. Between the lines.