Inside VC, Decoding Investments — Analysis

This is the second part in the journey of decoding investments. In the last part (here) we delved into the construct and curation of a dealflow — the first step of the investment journey.

The second step, Preliminary Analysis or Initial Filtering, varies across from investor to investor. While some investors prefer the route of filtering businesses based on certain business metrics, others prefer their first point of contact to be an introductory call basis which they decide, if the investment fits.

However, either type of investor filters the deal on one common metric — The Investment Thesis.

What is an investment thesis?

An investment thesis is a formal set of directions and filters that articulates the rationale for investing. It serves as a comprehensive framework that guides investment decisions.

A venture capital thesis in general can be understood by, and for Auxano being:

1. Focus: Next-Generation, Technology-Led, Consumer-Focused Businesses driven by Subscription/ Secular Income Economy
2. Approach: Category Creator or Market Creator or Market Leader
3. Sector: Sector-Agnostic
4. Stage: Pre-Series A — Pre-Series B, Pre-IPO

While this is not an exhaustive list, the mentioned parameters can be commonly observed across investment thesis.

At Auxano, we receive over 250 deals every quarter, the following parameters help us in establishing the initial filters on the pool of opportunities. To understand the extent, 250 deals get filtered down to < 50, with the initial parameters in play and further < 20 as we deploy our proprietary score-card analysis method

Deals that fit the thesis undergo our evaluation scorecard. Our Scorecard, is a weighted combination of 13 parameters housing a total of 50+ sub-parameters. Companies are assigned scores based on their fulfillment of these parameters and for the ones that cross the threshold , pass this initial round of filtering.

What forms this Scorecard:

1. Problem Statement: Clearly defining the problem ensures the startup addresses a real need. We look for problem statements with significant validation, as these often indicate a strong market demand for effective solutions.
2. Solution to the Problem: The proposed solution must be innovative, scalable, and feasible. We assess whether the solution is unique and if it can effectively address the identified problem better than existing alternatives.
3. Market Size: A large and growing market is crucial. We prefer investing in startups that target large market opportunities, as this increases the potential for significant returns. Total Addressable Market (TAM), Serviceable Available Market (SAM), and Serviceable Obtainable Market (SOM) are key metrics. SOM is the key.
4. Business Model: A sound business model outlines how the startup plans to generate revenue and sustain profitability. We evaluate the model’s scalability, sustainability, and the likelihood of achieving long-term financial success.
5. Stage of the Business: The development stage (e.g., seed, early, growth) impacts the investment decision. VCs have different risk appetites and return expectations depending on whether the startup is pre-revenue, has a Minimum Viable Product (MVP), or is in the scaling phase. We prefer businesses that have market validation and early revenue.
6. Revenue Model: Understanding how the business plans to make money is essential. We look at the revenue streams, pricing strategy, and the predictability of revenue. Recurring revenue models often attract more interest due to the secular cash flow.
7. Technology Integration: The degree to which technology is integrated into the product or service can be a significant differentiator. We favor startups that leverage technology to create competitive advantages and scalability.
8. Traction: Demonstrated traction (e.g., user growth, partnerships, sales) is a strong indicator of market validation. We look for evidence that the startup’s product or service is gaining acceptance and showing potential for growth.
9. Team Dynamics: The quality and cohesion of the founding team are critical. We assess the team’s expertise, industry experience, ability to execute, and how well they work together. A strong team can often pivot and navigate challenges effectively.
10. Competitive Landscape: Understanding the competitive environment helps us to gauge the startup’s positioning and differentiation. We analyze direct and indirect competitors, entry barriers, and the startup’s unique value proposition.
11. Valuation: Valuation impacts the potential return on investment. We consider whether the valuation is justified based on current performance, market potential, and comparable companies. We seek investments that offer attractive risk-reward ratios.
12. Regulatory Impact: Regulatory considerations can significantly affect a startup’s operations and growth potential. We examine the regulatory landscape to identify potential risks and compliance requirements that could impact the business.
13. Exit Opportunity: We invest with an exit strategy in mind. We evaluate potential exit routes such as acquisitions, mergers, or IPOs, and the likelihood of achieving a lucrative exit within a reasonable timeframe.

Deploying this scorecard also highlights the inefficiencies in the business, which can be worked upon with the promoters.

Takeaway and Insights:

Investment filters don’t simply categorize deals as good or bad . The primary goal is to identify those where investors feel most at ease. This becomes increasingly important given the high volume of dealflow investors often face.

Moreover, the initial detailed screening serves as valuable feedback for promoters, offering insights that can help refine their business strategy based on investor experience.

Finally, while excessive data is not required in the investment pitch deck, it is crucial for founders to highlight key points, including those discussed above, to effectively capture investor interest.

And with the evolving landscape it’s always a learning curve. Adapt & adopt.

Author:

Kanuj Jadwani