Who would you invest in? Anyone seeking angel or venture capital should ask themselves this question, because chances are, the investor they're pitching is probably an entrepreneur, too. It goes with the territory. The people willing to invest in early-stage ideas are those who have the same entrepreneurial spirit, the ability to envision what might be possible, and the guts to make a highly speculative investment in it.
I can't speak for every entrepreneur who is a private equity investor, but I believe my criteria are comparable to what others are seeking. So I'll explain the attributes I look for in other entrepreneurs. As an example, I will discuss Keith Murphy and his venture, Organovo (NASDAQ:ONVO), which I made an early-stage investment of over $1 million in.
There are three rules to abide by:
Rule #1 – Early-stage investments are in the people, not the ideas
One of the biggest fallacies is that all you need is a great idea. In reality, a great idea is useless by itself. Great execution determines success. If an investor hears a brilliant idea but isn't confident the entrepreneur can make it happen, he'll pass.
When I invested in Organovo, the company's technology of bioprinting took a distant second place to Keith Murphy, chairman, CEO and co-founder. If Keith wasn't the right person, I knew the technology – no matter how impressive – wouldn't matter. More often than not, good technology can't save bad management from messing the whole thing up.
In staying on top of the regenerative medicine industry, I had stumbled across a blurb in a trade publication about Keith and his new venture. After some preliminary due diligence, I reached out to him to find out more about his work. This led to phone calls and in-person meetings, where I drilled him with tough questions, not all of them purely focused on business.
I wanted to find out his character and way of thinking. What were his beliefs about certain practices? Was his outlook for the future pie-in-the-sky, or was he grounded in reality? Could he -- and would he -- afford to forfeit a salary if times got tough? How fiscally conservative was he? I didn't pull his credit report, but if I had concerns, I absolutely would have. He passed my interrogations with flying colors.
Rule #2 – The business idea needs to have a proprietary advantage
The business idea may be second on the list, but it still needs to be rock solid.
So what falls under the "rock solid" category? Many early-stage investors will insist that the business model have some sort of proprietary advantage: something that is a barrier to entry for competitors, something to minimize the risk of being ripped off.
In the case of Organovo, this was intellectual property. They have a lock on the bioprinting technology developed by Professor Gabor Forgacs (company co-founder) and his team at the University of Missouri, Columbia. Later, they also secured an exclusive license for a competing version of the technology (using a modified inkjet printer for bioprinting) developed by Dr. Thomas Boland at Clemson University. As described in Organovo's Form 10-K filing:
"Competition in the bioprinter arena has been limited to date. We believe that we have a first to market advantage in being the first and only company to leverage a purely cellular bioprinting system commercially, which does not rely on the presence of foreign, non-native polymer in the final tissue constructs. Some academic groups have internally created inkjet bioprinting systems, but these systems have not been developed commercially to date and are unlikely to be as effective in the generation of larger-scale 3D tissues. Futhermore, commercialization of certain inkjet based technologies will require certain intellectual property rights."
That's the type of competitive edge I like to see. But patents certainly aren't the only form of a proprietary advantage.
An ode to what I said in Rule #1, the talent and skills an entrepreneur possesses can make an idea rock solid, even if the idea itself is not patentable. If the entrepreneur's knowledge and knowhow are irreplaceable, it'll be difficult for a competitor to replicate. I've found this to especially be true in highly specialized technology niches, where there may only be a handful of people who actually know the field.
Alternately, if the entrepreneur is already an accomplished veteran of a given industry, that alone can serve as a proprietary advantage. For example, if Joe Schmoe – with no food industry experience – was pitching a fast casual restaurant concept, few investors would listen. But if he was a seasoned high-level exec from Chipotle or Starbucks who was looking to quit and start his own concept, investors would take notice. Having a proven track record and valuable business relationships can go a long way.
And there are other ways a business can have a proprietary advantage. If a competitor can't copy your concept overnight, then being the first mover might give you that edge. Even if others do the exact same thing you are, being established can demonstrate to the investor that you have the potential to be a viable competitor.
Rule #3 – The entrepreneur needs to prove his worth with a little, before getting a lot
Not only does the business concept need to be solid, the chemistry of the people involved needs to be considered before investing a large sum. My very first investment in Organovo was only $30,000. Sure, Keith passed my scrutiny, but I needed to monitor the progress before putting more chips on the table.
Keith consistently proved that he could deliver results: a partnership with Pfizer and a year later, with United Therapeutics. Despite a shoestring budget, Organovo demonstrated the ability to get the word out about its work – both within industry circles and the general public. With the latter, bragging rights included coverage in The Economist and being named one of Time magazine's Best Inventions of 2010.
While those accolades may be impressive, an entrepreneur simply needs meaningful progress to impress the investor. It doesn't have to be that grandiose -- just growing and moving the business in the right direction is a significant accomplishment that won't be ignored. Many entrepreneurs don't deliver even that after they get the check.
But what has impressed me the most about Organovo is the caliber of team the company put together.
Entrepreneurs can give themselves a leg up in the eyes of investors if they have a veteran on board. Organovo hired Barry Michaels as CFO, a position he's held at three private and three publicly traded companies during his career. For an investor, this was an important missing piece of the puzzle – someone who had been around the block, with the wisdom of experience.
Entrepreneurs can increase their appeal by bringing on impressive talent (as long as that won't lead to internal conflict). Long before Sharon Presnell came on as Organovo's CTO in 2011, I was a fan of her work and actually invested a small amount in her prior employer, Tengion.
While the aforementioned investments in Organovo were made before it became a publicly traded company, I didn't exercise any of my warrants (which represented over half the dollar value) until afterward. Why? Primarily because I wanted to see the chemistry of the team over a longer period of time before doubling down.
Ultimately, entrepreneurs will need to prove themselves in every way before they get the "big bucks." This includes work ethic, values, delivering progress, and demonstrating that their team works well together. When all of those pieces are in place, it's an investment worth considering.