While risk of startup mortality is real, so is the potential to earn 10x returns on your investment. And the quality of curation plays a significant role in predicting returns on your early stage investments.
Why is curation important?
According to Kauffman foundation research, 56 percent of companies fail, giving their investors negative returns. For this reason, angels invest in portfolios of companies. Among the successful companies, 9 percent provide investors with returns of 10 times their investments, which compensates for failed investments. Additionally their research on angel investors in Asia, suggested that between 75 to 79 percent reported returns meeting or exceeding initial expectations. The study attributed the results to angels’ commitment to in-depth due diligence before investing and close monitoring of investee companies.
Evaluating business ideas with new technology, no track record and selective market evidence is a balance of science-and-art. A robust evaluation framework ensures that we lay emphasis on a holistic business evaluation while going deep in individual elements. Also, there are unique elements in evaluating early stage businesses that are different from evaluating more mature businesses for debt / equity investments.
Key elements of our curation framework are outlined below:
1.Ecosystem and Timing
While products / services need to fulfil unmet needs and / or replace existing solutions with higher net value, it is important to note that success is significantly dependent on where the product fits into the bigger scheme. For consumer-facing businesses, this encompasses existing affinities, habits, technologies and aspirations. Imagine, for example, the relevance of Robinhood in the absence of smartphones and users’ comfort in completing online transactions. For business-facing products / services, this gets a little more complicated. Institutional decisioning is more likely to be influenced by more fundamental shifts e.g. policy / regulatory changes. Take for example, Healthcare. Across the world, there is a rise in healthcare spend but it’s now reaching unsustainable levels. The response includes an integration of datasets across healthcare providers, wearable tech and pharmaceutical companies to evaluate trends and outcomes and drive pointed interventions to draw innovative product design, increase member engagement and improve preventive care.
Equally important to Ecosystem, is the timing element of a new product / service. Startups need to balance addressing immediate user needs to find revenue and survive but they also need to have a future-facing product to ensure they are relevant as they scale over time. This implies a deeper understanding of how their product and the evolving ecosystem will shape the needs of tomorrow and evolving solutions.
ShiftAltCap curated business: B2B funding for working capital of SMEs SME lending has been perennially plagued with problems of being underserved due to higher risk, cost to serve and disaggregated demand. With the new emerging world order, SMEs are breaking new ground both in terms of market access as well as ability to serve. While traditional players such as Banks, NBFCs are not able to carry the mandate, alternate credit scoring and automated credit underwriting can mitigate lender risk.
Premised on the concept of trade flow financing using in house and external marketplace for large companies with long supply chains, the company aims to simplify global trade transactions for buyers, sellers and financiers. The platform organises the market by ensuring asset quality and transparency on the underlying data. Decision: Go ahead
2.Go-to-market and Ability to Pivot
Truly the raison d’etre of any business; this is the criteria where all the action eventually culminates. Its also one of the hardest criteria to pass muster with us. The action plans for businesses vary significantly and there is almost no certainty beyond a few basic principles. Equally important is for the company to be able to pivot to meet the customer needs if it discovers that navigating the traction gap with the current value proposition is difficult.
To a great extent the success or failure likelihoods really get shaped by the company’s ability to acquire and service the market in this phase. For this reason, ShiftAltCap chooses to work with businesses that enter the investment round while they are going through their go-to-market phase or as they enter the traction gap (a beautiful term coined by WildCat Ventures) between initial product release (IPR) and minimum viable traction (proven growth curve).
ShiftAltCap curated business: real-time, hyper-local air quality data at 1/1000th the cost India is home to 14 of the 15 most polluted cities in the world and has the highest number of deaths and critical illnesses due to pollution globally. Judiciary and Government bodies have been creating awareness and taking steps to manage the situation but are constrained by the quality of measurements. The average sensor costs $150,000 and therefore, in all of Mumbai there are 2 sensors. The company started by creating a sensor that would cost $50–70 and would leverage IoT to offer real-time, hyper-local air quality data. The sensor could be packaged as a measurement device or as an air purifier. However, the company has now pivoted to keeping the sensors on their balance sheet, to develop a predictive machine learning based air quality model that uses data from sensors, satellite imagery, pollution data and meteorological data from multiple data sources such as governments across the world to provide pollution insights at > 90% accuracy. This provides it enormous opportunity to penetrate into the pollution data intelligence market. Decision: Go ahead
3.Ability to execute
At the core of every successful business is the ability to execute relentlessly towards the vision. In the case of early stage businesses, team sizes are small and reliance on each individual is high. It is important that the teams have clear paths laid out, know where to begin and when stuck, have the ability to think their way out of the jam. Usually, we prefer to see evidence in the form of early revenues, on-ground experience of the teams in their market environment and feedback from key customers on their experience.
ShiftAltCap curated business: leverage digital to strengthen rural education, improve learning outcomes Deteriorating quality of education is creating massive gaps with nearly 40% Grade VIII students unable to tell time, perform division or add weight in kgs. With 22 Mn students and 75% parents prioritising education in their top 3 to dos, there is significant unmet demand. Yet, 70% rural 18-year-olds are enrolled in formal education programs; 6x from 10 years ago. The company is focused on using local vernacular digital content delivered in local education centres for students in middle school of State Education Boards (which cater to 84% of students in India). To be affordable, the centres leverage existing school premises during their off-time in rural districts and equipped with equipment to enable content access (Internet), projector and a white screen. With strong discipline, each centre can have payback period of less than 1 year generate margins upwards of 30% with as low as 45 students. The company is led by IIT-K graduates with 15+ years of experience who are well-networked with State Education Boards to enable on-ground cooperation. At the time of our assessment, the company was still investing in building a strong pool of teaching assistants to provide student hand-holding in Bihar suburbs. Also, value proposition to first set of students and parents was not clear. Decision: On Hold till execution evidenced
4.Founders
Given the small team sizes, early stage businesses have a higher reliance on individuals which means that each member of the team needs to be evaluated for their commitment to the business, their understanding of the market, relevant experience, their stake in the business and their opportunity costs. There are lesser obvious dimensions e.g. who are the informal mentors for these founders, how long back do they go together, how far apart are their non-work ideologies which matter equally in evaluating business and whether founders will stick together when the going gets tough.
ShiftAltCap curated business: AI-based news sentiment analyser The product would parse through existing news content from different agencies and classify it as biased in favour or against. This would offer readers a choice to compare competing points of view. This product is especially relevant to companies such as investment banks and trading desks that need to process real-time feeds to be able to take calls on their existing / new positions for companies and industries.With volume of content exploding, half of humanity online and recent surge in attention on ‘fake news’ the product is well-timed. A comparable in China quickly became a unicorn. Low operating costs and significant product reuse were good news. The founders came with strong academic backgrounds and relevant professional experience. However, they were under significant influence from an ex-founder who had misled investors in his earlier venture. Decision: No Go
5.Growth Potential and Fair Value
Early stage investing is an asset class that is riskier than quite a few others in an investor’s portfolio. It is natural that the higher risk commands a higher expected return from individual assets as well. In terms of evaluating businesses for investment, this implies figuring out the revenue potential of the business. For instance, does it have a large enough total addressable space and what part of that total addressable space can be serviced by the business we are evaluating. Valuation then becomes a question of the likely upside that the investment will see and whether it can carry the risk posed by the sub par performance of another investment in the bouquet of early stage investments.
ShiftAltCap curated business: Personalised medicine for cancer patients through liquid biopsy Lines of treatment in Oncology vary significantly based on sub-strain of mutations. Current methods for detecting and diagnosing cancer have inherent limitations — tissue biopsy is invasive and restricted to few organs and not repeatable if organ is removed, CT Scan is a radiation hazard and can only detect malignancy. In 2016, US FDA approved Liquid Biopsy as a companion technique to diagnose the sub-strain and in the process, get one step closer to personalised medicine that can truly make the difference of life and death. India, however, has no indigenous technology for conducting this test. The current methods include shipping samples over cold chain and / or importing expensive equipment and reagents; offering only one subset of tests (ctDNA) at an exorbitant price. Also, these tests are not recognised by ICMR and hence, not covered under insurance. The company is developing an AI-based product that will parse tissue samples through computer vision. It is extending liquid biopsy to its fullest potential by extending testing to CTC and exosomes as well.
Potential: Cancer incidence is on the rise across the world with India reporting the highest growth rates and absolute number of patients. The global CTC market is expected to reach USD 11.6 Billion in 2022 with a CAGR of 15%. The new cancer cases are expected to increase by 70% over the next two decades Total addressable market of 14 Million patients with ~12% serviceable available base. Decision: Go ahead
6.Domain Validation
Equally important to ‘What?’ and ‘How’ of evaluation is the ‘Who?’ ShiftAltCap leverages an extensive network of domain experts and industry leaders to evaluate the startups that get past the first 2 levels of screening. Domain experts have a deeper understanding of the market and are able to engage with founders at grassroots and strategic levels to refine market dynamics, critique product features and sharpen value proposition to buyers. Our domain experts, typically, come with 2 decades of industry experience working with global leaders and have a history of investing in, mentoring and buying from startups.
ShiftAltCap curated business: New paradigm in cryptographic binary security keys The firm had created a new algorithm for strong binary keys that need L/2 cipher which makes them practically tamper proof and multi-fold stronger than existing solutions that are based on 2*L cipher paradigm. Several application areas and all growing at strong CAGR. Founder is an NIT-K graduate with Masters from Kellogg. 30+ years in e-payments, NFC and proximity payment focusing on ICT and related applications. He has extensive experience with the FinTech industry with focus on Machine Learning, Intelligent Data Models for behavioural patterns recognition, UI/UX, large scale and wide reaching applications. However, ShiftAltCap’s domain experts advised that the buyer segment was extremely concentrated and unlikely to either engage with startups or approve a capital expense to change their encryption systems till faced with a systems crisis. Decision: On Hold
Are all good deals also good for individual investors?
We have asked this question to ourselves several times. There are deals that have significant burn rate and will keep coming back for further rounds till they get to a cash positive stage. For instance, some, by design, have long runways as they develop IPR or ambush incumbents with well entrenched moats. Similarly, there are others where the concepts are too risky though if the concepts get market acceptance, they can scale exponentially. There is no one-size-fits-all response. That said, one common underlying principle that individual investors need to be cognizant of is that these investments require deep and patient pockets to derive the desired returns. Hence, in such cases, we ensure risks are transparently laid out while we act selectively before onboarding the business for fund-raise.
ShiftAltCap curated business: Converging advertiser, publisher and user interests through a new technique In 2017, consumption of digital media overtook the consumption of TV in US. Globally, the same is expected to happen in 2020. Internet is now the preferred medium for news, entertainment and of course, communication. As time spent online clocked past 8 hours daily, it was natural for advertisers to flock to publishers and marketplaces such as Google and Facebook which offer rich audience segment data in addition to publisher inventory access. There are challenges that publishers continue to face: only a small segment of their inventory is worthy of ads, users are not willing to pay for content, shelf life of content is shrinking courtesy social media. The company is creating a new mechanism to monetise publisher content. They plan to launch a virtual currency that basically puts a value on user attention. This means that if the user watches an ad, he / she earns the currency and can redeem the currency for consuming content. The company uses AI to track user interests and offer relevant content and can be seamlessly integrated with existing paywall solutions of subscribers. However, the company has completed IP development and is near GTM. They have consumed $11 MM and are seeking a round of $3MM that will last them about an year. Given the late stage, we have not recommended this to our investors. Decision: OK to consider for fund-raise. No go for angels.
Concluding Thoughts
We have always maintained that curation is far more than financial and legal due diligence and cannot be treated as a checklist activity. We have a robust framework but we also understand that no framework can holistically address the wide and growing variety of new businesses on the world stage today. It comes down to evaluating businesses in detail, with industry experience and keeping the above pointers in mind. Data from international markets validates our thinking. Here is a snapshot of the distribution of returns and how its influenced by different levers:
Notes from the above study: (a) Profile of angels: 10 investments, over 9 years of investing, 57 years of age, 10% of wealth in angel investing, post-graduate (b) The study covered 538 angels with 3,000+ active investments and 1,100+ exits and closures (c) 34% of investments were in seed stage, median investment of $50K
Note: Details of the individual startups demonstrated in our curation examples have been masked to be in line with our data confidentiality philosophy.