This post is by Jeff Carter from Points and Figures
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At the seed stage, you see a lot of good ideas. Entrepreneurs solve a problem and the solution looks pretty interesting. But, it might not be investible.
This is one of the trickiest thing when you are investing. Is the idea scalable or not? Yes, it works for the initial MVP, but can it get big? If so, how big? However, it’s more than that.
Suppose you invest in a seed round at an acceptable valuation. You get a nice chunk of equity and you are comfortable with it. The company starts building and things seem to be going well until a few years later when it becomes apparent that the company is going to have to raise millions and millions of dollars to get to the exit. The price appreciation of the valuation doesn’t keep pace with the capital the company brings in. There might be preferences in new that push you down the cap table. Maybe they had to incentivize new investors with promised dividends. Your investment gets so diluted in the process that you really don’t get the bang for your buck.
Complicated businesses can be like that. In Fin Tech, exchanges can be like that depending on the market they are trying to corral. SaaS businesses can be like that too.
For small funds, another layer of diligence is trying to game out the future funding rounds to figure out how much capital it will take to get to a realistic exit. Not every company will be a billion dollar company. Yet, they might still take a lot of money to get to a $100MM exit. This is something an angel ought to pay attention to as well. Your investment might be like peeing in the ocean.