Venture capital triage process, part 2: Objective signals, strategic priorities and compelling factors

By Pavel Cherkashin

[Almost confidential] Internal instruction for beginning venture analysts on how to quickly sort through incoming deals

Source: Shutterstock

In the previous post, I outlined a triage process for screening incoming startup pitches and building a pipeline of projects that merit further investigation. I mentioned that an analyst should pick only projects that have objective signals, align with the firm’s strategic priorities and exhibit compelling factors, but I didn’t explain what those terms mean. Here, I’m going to review them in detail.

Objective signals

Here are the objective signals to look for as you’re screening incoming deals. Keep in mind that objective signals are very rare.

· Strong investor attention — This is the strongest signal. If other investors are going crazy about a particular startup, most likely there is something valuable about it and you just don’t have all the information. If the startup is oversubscribed or hard to reach, it’s a good indication you need to not merely flag the item for immediate action, but actually get a partner in contact with the founders or co-investors right away.

Example:

“Our current funding round is closed already, but I thought you might be interested in getting on our waitlist for the next round?”

“Wait! Let me connect you to one of our partners!”

· A strong recommendation from a trusted partner — Every firm has a short list of trusted co-investors, advisors and founders whose word carries a lot of weight.

Example:

“Sergey Brin suggested that we might be a good fit for your fund; how about we grab coffee sometime next week?”

“Sure. Let me invite our partners to join us!”

· Competitive intelligence or a unique market insight — This when you learn something from competition, partners, influencers or even media that may change the market or create a new opportunity. Quite often, this pops up in conversation and might not be related to the deal you are discussing.

Example:

“We are launching an online marketplace of entertainment services for people who will need no sleep and have lots of spare time.”

“Wait, why won’t they require sleep?”

“They will be taking this new stay-awake pill by startup X.”

“Startup X you said? Can you spell that?”

· Extraordinary traction — Any startup growing significantly faster than the rest of the market should be considered with higher attention than the others. Just be sure to mind the effect of a low base; growing from 10 to 1000 users looks impressive when presented as a percentage, but is not significant from a business perspective.

Example:

The main KPI in consumer mobile applications is user retention after 3 months. If more than 60% of those who install the app are using it regularly after 3 months, this is a clear signal that the developers of the app found a valuable use case. A retention rate of 20% or lower is considered noise level. Anything in between is acceptable from a business perspective, but is not considered an objective signal.

Strategic priorities

Because signals are rare, you can’t build a healthy pipeline if you wait for them. So if there are no signals, check the list of the most challenging and strategic problems for the industry you are responsible for. This list will vary from one firm to another, and it will normally change every 6–12 months, although some challenges hang in there for decades.

Here are some key phrases from our wall (which may be obsolete by the time you read this):

Neural network processing on Android devices

Cheap laser sensor for 3D vision

Compact eye projector for augmented reality (AR)

Grandma-proof bitcoin wallet

AI for network routing

Source: Shutterstock

Of course, if there are no solutions in a given area, there may be no ready market for one, either. But who wants to miss out on the opportunity to create a new market, once the solution is there? The truth is that any venture industry has technological bottlenecks; startup founders who have a clear vision of how to overcome them should be at least given a chance to make their pitch.

Note that if a project promises a revolutionary solution, it should be flagged for immediate action even if the other criteria are not met. In the big puzzle that is venture business, one missing piece can complete the whole picture. Investing a few minutes to explore a promising opportunity is better than throwing away the chance. Even if your firm decides to pass on the investment, knowing that the solution is coming to the market might shift your current investment priorities (or help your firm’s portfolio companies with valuable insight).

Example:

The whole should-be-a-trillion-dollar industry of AR is on hold for a simple reason: There is no compact projector on the market that can be integrated into glasses. Several companies have attempted to deliver the solution but failed because they underestimated the complexity of the task. Even if your company invests only in AR software and content, not hardware, knowing that the solution is coming to the market is essential, because it will influence the types of software and content that will be produced in the near future.

Compelling factor (Sense of urgency)

Once you have identified a startup with clear market signals and/or strategic priorities, you need to make one final check: How urgent is the decision about it? Does your firm have to make a decision now, or can it wait? If it can wait, can it wait until next week? Next month? Next year? And what changes could occur that might make the investment decision urgent?

Explicitly choosing to wait is not procrastination. If there is no urgency, maybe the market is not ready for the proposed solution. Waiting also enables the firm to watch the project and see if it gains the necessary traction to become a more attractive investment target.

***

Pavel Cherkashin is a cofounder and a managing partner at Mindrock Capital and a managing partner at GVA Capital. A former angel investor and entrepreneur, he now invests in cryptocurrency, artificial intelligence, blockchain and self-driving tech.