What Index looks for in an investment
Posted on 05 Feb 2014 by Ben Holmes
Common to all these successful companies were three things: a passionate and committed team; an innovative and disruptive business idea and a large market opportunity. Without these factors, it is unlikely that raising venture capital will be the right thing for a business. Not every business that fulfills these criteria will get funding, but Index Ventures will certainly want to engage with those companies that do.
Passionate and committed founders. The early obstacles that a startup faces are to get funding, recruit talent, build products and gain early customer traction. Without passionate and visionary founders, a business will struggle to engage potential employees, investors and customers. Venture capital is fuel for a fire, but the spark to ignite the startup journey must come from the passion of the founders.
Once the initial hurdles have been overcome, few startups achieve success immediately. There are almost always unseen challenges and building a valuable company requires commitment to overcome or navigate around boulders that block the road.
Finally Index almost always prefers to back a founding team rather than a lone founder. Having commercial, operational and technical talent within the founding DNA of a company will give it a better chance of success and we look for teams that bring together all these elements.
Innovation and Disruption. There are two elements that underpin an innovative business. Firstly the founders must have a unique insight about a market or problem. Secondly they must have a creative and innovative product or service that leverages this insight to disrupt the way a market operates or provides a creative and new solution to a problem. Innovation can involve developing a new technology, but not all innovative businesses are technology businesses. Many of the most successful startups use off-the-shelf technology but devise radical and innovative marketing or distribution techniques which can transform the economics of an industry.
Market Size. Our funds seek to gain “significant minority” stakes in companies where we invest. Our model is always to back founders rather than act as business owners like buyout investors. Since we typically own small stakes, we need to have conviction that a business can ultimately exit for many hundreds of million or ideally billions of dollars/euros. We are unlikely to pursue investment opportunities where the absolute return for investors is capped by market size constraints, even where relative return on investment may be positive.
How best to approach Index Ventures
At Index Ventures, we have visibility on a large number of investment opportunities and have to rapidly focus on a much smaller set of companies where we can devote sufficient time to understand the companies and build a relationship with founders before we invest. Generally our dealflow can be categorized into three types
· Deals sourced through thematic research. We continually undertake research into sectors or industries where we believe disruptive companies can emerge;
· Deals referred through our network of current and former portfolio companies, VC industry colleagues, angel investors and advisors;
· Deals where companies spontaneously and directly contact Index Ventures through email, social media or events.
All three of these routes are important to us and each has yielded successful company relationships in the past. It is true that the companies where we already have strong direct or indirect relationships with founders are more likely to receive investment. However some of our most successful investments have been from backing first time entrepreneurs who had no prior ties to Index Ventures.
If you are considering approaching Index Ventures, you should bear in mind that the approach you take to raising capital provides a prospective investor with a good insight into how you will run a business. An approach that is well researched, well targeted and politely persistent is far better than an undifferentiated shotgun approach. Specifically we would have the following tips:
Be well rehearsed. There are many events and forums where you can see other companies present and road test and iterate your own business plan. These are highly worthwhile and we always give credit to entrepreneurs who over time show an ability to iterate and an openness to change and improve an initial idea.
Be targeted. Think carefully of why your business is likely to be of particular interest to Index Ventures given past and current investments and any comments we have made at events in the press or social media. Think who specifically at the firm is the most relevant person to try to build a relationship with given your sector, stage and geographical focus.
Build a relationship. We are always positively disposed to founders who are able to share with us some information over a period of time about how they are developing their business before we have more explicit dialogue about an investment round. Events and social media as well as email provide a great way to engage with us in a more informal way well in advance of more formal and focused meetings and presentations.
Execute on what is possible with no funding first. How much you are able to achieve without funding is a strong indicator of what you will be able to achieve once funded. We are much more compelled to invest where teams have done extensive market research, built prototypes or alpha products and road-tested marketing campaigns before raising funds.
At Index Ventures we try to get back to all prospective entrepreneurs, however there are inevitably times when we are unable to do so to every company given the volume of inbound leads we receive. Also we make a decision to invest based on something exceptional we see in a particular Company. We therefore will not always be able to elaborate specific reasoning for not pursuing a particular investment opportunity.
Finally we are humble and always learning. Where we have not initially believed in the vision or trusted in the execution of founders, we are always delighted to engage again with entrepreneurs who have proved us wrong.