Evaluation framework for early stage-early growth stage firms

Have been thinking a lot about a framework for evaluating early stage/early growth stage companies and what are the factors we look. Usually, the question to ask is — Will this investment give us a 10x exit in 5–7 years?

Broadly, as anyone would have guessed, the answer revolves around evaluating Teams, Product and Market.

When I think about teams, there are two broad questions to answers here –

1. Does the team have an ability to create a fantastic product which market needs or doesn’t know it needs but will lap it up nonetheless (This is a super category). How is the team-product-fit, the team-market-fit? What are the ‘soft’ characteristics of the founders? How are the core team dynamics? Is the founder a capable product person and a leader? What are the risks we are taking here?
2. Does the team understand the Go to Market strategy and its importance? How well do they know their market, potential customers, customer segmentation, pricing & business model, plan & channels through which to reach and sell to customers / acquire users? There are early signs in terms of increasing user references and ready buyers. Or not.

In terms of team fit, most the teams we really liked in first parameter, faltered on the second one. There is a lot of great products engineering wise, but no buyers since much cheaper and marginally lower tech products rule the space — We recently talked with a great product team whose product we were sold on. We just couldn’t figure out why the buyers will buy thus, despite being a premium user of that product category ourselves. Case closed.

Coming to product, there are again two questions to answers in terms of product risks -

1. Product risk. Identified as a combination of technical product risk and operational product risk. With the aim to understand the degree of complexity involved in delivering the product or service in question. Is it even a viable product which can be delivered at scale?
2. Market risk. With the aim to understand whether there is clear demand for the product or service being offered. Looking at the competition, market dynamics, timing, traction, user feedback. Who are the buyers here? Is that a big enough set? Or a potential big enough set given the product benefits.

In terms of market, the usual way to think is “Is there a huge market for the product?”. While that is a valid line of thought, I also add one more category which I actively look at — Can this product create/address a latent market which is huge but also not served currently by bigger players? Because, if a market is huge and unfragmented, there is a reason it is the way it is — It might just be the case that unorganized players are efficient and organizing it is not going to add anything (There are markets where organizing it might be counter-productive — Home materials?).

Other cases might be that “latent” market is huge but no player is serving them because it’s either uneconomical (SaaS for SME in India?) or nonviable or unprofitable (Most of the fintech in India targeting bottom of the pyramid users?). If there is a real product for these problems, there is a potential winner.

The answer using the framework outlined here and the answers in totality, not in isolation, is where it gets interesting and further analysis starts making sense. They point towards where to look for. Say if we are sold on product and team’s engineering capabilities, we jump straight to potential go to market study and the market study itself.

And if it’s a currently small market and we believe that timing, dynamics, and a strong go-to-market approach give them an advantage towards taking a large part of it, we believe we need to spend more time with the team.

Internally, higher the conflict around these market sizes and potential, better the outcome. If everyone is a Yes from word go, there might be a chance that 10 other guys are doing the same thing and 20 other firms are investing in the same thing. There needs to be some amount of discomfort for outsized returns.

While a complete answer will include detailed due diligence process as well, will leave that for another article. This one outlines the process for initial screening. Would be happy to discuss these with fellow investors/founders.