There is a broad array of different investment criteria that directly influence the decision making of an angel investor. Some key factors that influence investors’ evaluation of startup s potential include detailed business plans, competitive advantage, previous knowledge and experience, personal preference, and an array of other non-financial considerations.
According to existing research, these attributes can be classified into 4 categories –
- Internal criteria – Construct related to the team and the entrepreneur
- External criteria – External factors like forces of the market, market size, competitor’s advantage, etc.
- Fit criteria – The fit between the angel and the entrepreneur, industry, and business.
- Technological criteria – Any form of breakthrough technology or innovation.
Numerous results from prior research are contradictory and inconsistent, which leaves young entrepreneurs in a dilemma to find the x-factor. Research in 1999 concluded that reasons why Angel Investors would decide to financially support a startup, are not the opposite of reasons they would reject the start-up resulting in the Investment Paradox.
The Investment Paradox
The Indian start-up scene is booming with 49,000 new start-ups emerging from 2008 to 2018, with an investment of almost $51Bn. This has inspired youth in the country to give their business models a shot, but a lot of them fail to get an Angel Investor to fund, even after a positive evaluation of the start-up. This tortoise and hare situation which intrigues the start-up circuit for decades is known as the Investment Paradox.
Investment Paradox occurs when the investors give a positive evaluation to the core, fundamental attributes of a new venture, yet the venture is evaluated to have low investment potential. This could be the reason why start-ups winning Hackathons and competitions score the highest in these competitive evaluations, but end up not receiving any funding. The paradox plays a critical role in evaluating the decision making-process of Angel Investors.
Industry-Angel and Entrepreneur-Angel Fit facilitating risk mitigation
The fit criteria govern the relationship between the external and internal investment criteria. Angel Investors provide investment at a very early stage of the start-up, where uncertainty and idiosyncratic risk is very high. Angel Investors look for new ventures to fund in the market niche they prefer, to have a better understanding and involvement with the start-up.
Another factor that mitigates risk is when angels possess similar experience and knowledge such as working in congruent industries. The Investor can accurately determine the resources that the entrepreneur possesses. Similar educational background also influences the start-up evaluation, facilitating Investor-entrepreneur fit, and reducing the overall risk associated with the start-up.
Some observe that Angel Investors are favorable towards start-ups from their industry, or an industry they have knowledge on. This assists the personal involvement of the Angel in the new venture, and a superior understanding, influential in mitigating risk.
Technology and Innovation Criteria
Innovation can directly influence the investment decision of Investors. Novel and out-of-the-box technology enables rapid scalability. A fresh idea or technology can be patented, reducing the risk associated with competition and acts as a barrier for the entry of new firms in the market. This results in a favorable risk-return ratio of the new venture and risk mitigation.
The investment paradox is common with even the best new ventures, which excel at the fundamental attributes of a successful start-up pitch. The paradox occurs because, despite the fundamental attributes, internal and external factors being right, there are certain industry biases and moderating effects that influence the Investor’s decision.
While further research is being conducted to determine the most effective and influential criteria for investment assessing processes, it is clear that the Investment Paradox exists. Entrepreneurs who seek funding not only need to ensure that their firm checks the fundamental investment criteria, they also need to factor in other evaluation processes like Industry Angel fit, Entrepreneur Angel fit, new technology, etc. This can help entrepreneurs determine which Angel Investors are the most suitable to approach.
- Cox, Lortie and Gramm. 2017. “The investment paradox: why attractive new ventures exhibit relatively poor investment potential.” Venture Capital Volume 19
- Feeney, L., G. Haines, and A. Riding. 1999. “Private Investors’ Investment Criteria: Insights from QualitativeData.” Venture Capital 1 (2): 121–145.