How to read Pitch Deck. Part two
The sequel covers details that did not make it into the first part. In addition, we will supplement some previous items to get a more complete picture.
At the club, we regularly hold offline events for members, sometimes showing presentations for internal use. One such presentation is called “Red Flags,” the text version we offer our readers for the first time.
Back to the Founders
The founders are the key people on whom the probability of a startup's future success or failure directly depends. As you remember from the first part of the story, they have special requirements that are different from the rest of the team. We know that you should pay attention to experience, workload, and shares. Now let's add focus to that list and expand on the point about competence.
Working in several startups in parallel is just as bad as working in one startup but on several products simultaneously. Sometimes we, as investors, come across several products in a pitch deck. As a rule, we are talking about the main product, to which all sorts of add-ons are attached. Let's call them chips. But this is at best. At worst, the marketer cannot explain which of these is the main product and which is not. After talking about one chip, the funder switches to another, confusing the pitch deck. As a result, you don't understand what the startup wants to offer and what it does. Such chips hurt pitch decks.
First, in the early stages, it's hilarious because the team hasn't yet gotten the basics right but is already fantasizing about something else.
Second, this approach leads to an uneven distribution of forces, slowing product development. Speed is one of the most essential qualities for a startup in its early stages. Seed money is not infinite, but quite the opposite. That's why it's contraindicated to do nonsense. Without a focus, the startup will use up investor money before bringing the product to market.
And third, if the pitch deck has no focus, neither does the startup. The founder simply does not know what he wants. In that case, the investment is a waste of time.
Let's take our portfolio company, Coterie's diapers, as an example. In the right pitch deck, you'll find diapers. Diapers, baby monitoring software, innovative nipples, and baby skin powder are in the wrong pitch deck. Goes might not be wrong, but it's better to return to them later.
Another interesting observation about startups that lacks focus. The founders of such companies tend to be more concerned about the distant future rather than the foreseeable one. It is always easier to think about what we are going to do in the next five years than tomorrow. A founder should concentrate on the following year at most. This will increase investor confidence.
What else will increase an investor's confidence is the level of knowledge of the founder. In short, as an investor, you should not know more about the product or the market than the founder. Who, after all, is launching the startup? This is not always verifiable by looking at the pitch deck alone. However, you may encounter this phenomenon during a call or in-person meeting. A casual conversation ends in a revelation: the investor knows more about the startup than the founder and answers questions he cannot answer. It shouldn't be that way. The founder is obliged to possess the fullness of information, which concerns all the processes within the startup. It is excusable not to know the details of the technology, for example, if we are talking about artificial intelligence. Then you can involve the CTO. But ignorance of the market, business, competitors, and other stuff makes a founder look like an amateur. In summary, founders should know more than you, not less.
If the founders lack competence, they can reach a plateau very quickly. This is a term from the field of sports when a person reaches his or her natural capabilities. In such a situation, the startup either cannot develop beyond a certain point, or it can, but with third-party involvement. This is bad news for the investor because you invested in one team, and now you are dealing with another. Your favorite is technically in the first place, but de facto everything is being run by gray cardinals. You don't know where this is going, and the unknown scares the money.
A separate point is ignorance of metrics. This is where many founders get lost. Ask specific questions about IRR, burn rate, and other statistics. If it doesn't take the team by surprise, that's a good sign. And while we're on the subject of metrics.
Dancing with the metrics
Metrics are tricky because there are few ways to sneak around. When reviewing pitch decks, you may encounter one of two extremes: either there are no metrics or many of them. A good option is when a startup only shows the key ones.
The creation of a quality product relies on numbers. A founder may not attach much importance to it and make do with Spartan unit economics, including the cost price, price, and planned revenue. Of course, this would not be the case in a good pitch deck. However, you and I don't know ahead of time what is hidden inside the presentation. So we have to study even such cases. No one said it would be easy.
The opposite situation also happens when a founder counts all possible indicators, making up even authorial ones. In this way, the startup aims to impress the investor with abundant numbers and calculations. It will have a stunning effect indeed, but not for an experienced investor. Such slides with tables will say only one thing: the founder has no idea what should be calculated and what shouldn't. A startup doesn't need numbers for the sake of numbers. It requires data for the company's and product's monetary feasibility. In other words, a startup needs exactly enough numbers to keep working, grow, and make a profit.
A founder should know which indicators are key for his or her startup specifically. By discarding the unnecessary and focusing on the essentials, the team will not only get rid of the investor's shock, but also help itself. What metrics do we consider bad?
Sign-ups \ App installs \ beta users. We also call them vanity metrics. We see activity that does not answer the question of where is the money.
Uninstall rate \ pre-booked revenue. Numbers for the sake of numbers. Useless metrics like these automatically indicate the startup's lack of real results.
If the founder has trump cards, he will immediately put them to work, and vice versa. If there is nothing to show, then, as a rule, the slide is stuffed with anything.
Poor unit economics
Many places in unit economics are easy to screw up. First and foremost, look at LTV, CAC, margins, capital intensity, and burn rate.
A low LTV indicates a rapid depreciation of a single customer over time. In other words, the consumer has paid once, for example, and disappeared. The startup will not be able to get more money from him. This hurts the other indicator, CAC, because if the LTV is low, the startup has to compensate for the revenue with the number of clients, not the quality. As investors, we want the LTV figure to be as high as possible. This can be achieved in different ways, for example, through subscriptions or value-added services. LTV is closely linked to the business model.
CAC means how much a startup spends to attract one customer. Think of it as advertising costs. The lower the CAC number, the better. With a high LTV, the investor and the startup get the best results.
Marginality expresses how much income we will get per unit of production. The higher the margin, the better. If you've never been in commerce, the margin is the difference between the production cost and the end customer's price. For example, startup X production costs $6, while selling it for $10. But suddenly, a competitor appeared, startup Y, which managed to reach a production cost of $2. There is no difference for the client, but there is a difference for the investor. The startup should strive to optimize the production of its product so that the cost is as low as possible. This will maximize income and profit.
It is important to note that entire industries have high and low margins. Low margins force a startup to sell more units and put in significantly more effort. A high-margin startup has the opposite. Low margins are typically found in consumer goods markets with a fast turnover and high volume. Avoid such calls and look at high-value-added products.
Capital intensity answers how much money a startup needs to take off. The lower the capital intensity, the better. Funds have limited funds (the irony), and not all of them can afford to get involved in such deals. And if they can, it's better to prefer a few smaller startups. It makes sense from a risk diversification point of view. High capital intensity makes you seriously think about the company's prospects because the cost of a mistake is elevated. In some industries, this is unavoidable, like fusion energy, but the players there are also appropriate. Look for startups that are not asking for all the money in the world.
Another interesting detail to pay attention to is scaling. How critical it is for the success of a startup. If a startup needs to reach ten markets or more to realize its vision, this can be considered a signal for failure. The opposite situation is much more attractive. The startup is focused on one primary market and is subsequently ready to move on. Trying to catch up with several markets at once does not lead to anything good.
And the last metric is the burn rate. How fast and how much money the startup spends per month, quarter, or year. The lower the speed, the better. A high burn rate can indicate problems with unit economics, salaries, or hiring numerous employees. Founders need to argue for this indicator because the investor is not interested in a constant injection of money.
Doomed market
A previous material discussed that a lack of competition is a bad sign. The same goes for a crowded market. Suppose many competitors are operating in the market the startup has chosen. In that case, it will be problematic to grab a share. More specifically, pay attention to the presence of so-called Big Tech companies among your competitors. These are technological giants like Amazon, Facebook, and others. Some startups may attempt areas and markets where the giants mentioned above are active with their products. Avoid such deals because declaring war on Big Tech is a thankless task.
Let's supplement the market section with a point about diversification. It is bad if a startup relies too heavily on one customer. There is nothing wrong with having a key or priority customer, but losing that customer should not ruin the startup. Pay attention to the funder's customer base. It should be as diversified as the investor's portfolio.
Another red flag is the lack of alternative channels for attracting customers. If a startup is confident in only one way of finding customers, this is cause for concern. What happens if that channel stops working? You need backup options, and not for a rainy day, but that work in parallel. This also strengthens the business model and shows its viability.
Suspicious Cap Table
The Cap Table is a sheet showing attracted investments, as well as the shares of the participants. Let's start with the obvious things. People who are not involved in startup operations should not own significant shares. Sometimes founders abuse this tool to attract talent. As a result, tempting pieces of the startup are handed out to just about anyone. Immediately see who owns the majority of the company. It should always be owned by the founders to prevent outside influence and loss of control.
And now the non-obvious things to pay attention to. It's a bad signal if a startup has no debt in the Cap Table. What does that mean? There is nothing wrong with taking out an ordinary business loan. Receiving a loan from a bank would be considered a positive signal in the eyes of an investor. It means that the company has been independently vetted and has gained credibility. But more often than not, startups prefer to give away shares instead of loans, which brings us back to the previous paragraph. A startup does not have to give away a claim if it is confident. It is easier to take out a trivial loan.
Risky round
Consideration of a round is a stage that investors rarely describe. This is where the funds study not just the startup, but their own kind. The first thing that should alert you is the absence of past investors in the new round. Former investors have insider information about the startup. If that information does not inspire confidence in them, that is most likely the reason they pulled out of the deal. After all, why continue investing in a startup that has performed poorly in the past?
In the early stages, the presence of a strategic investor in the deal should be avoided. A strategic investor is a company whose activities are related to the startup's business. In other words, a potential client invests in the startup. Such an investor constrains the startup and limits its scaling potential. Here's an example. A startup that develops software for chocolate factories is invested in by a strategic investor, Ferrero. As a result of the deal, the startup loses the opportunity to sell its product to Ferrero's competitor, Mars Corporation. Think of it as the equivalent of an exclusive. Founders trade growth for stability. A strategic investor is likely to dictate terms to the startup. Other investors will have a hard time.
The participation of the same lead investor in a new round is considered a cause for concern. Funding from the lead investor, again and again, leads to an increase in its share. Because of this, other investors, i.e., us, lose voice and dance to someone else's tune. As a rule, a startup should not be interested in this.
Hiring outside consultants, investment experts, and brokers is not approved. This is a waste of money. Funding should be sought by the founders.
And the last red flag for today is the time it takes to raise a new round. If a startup can't find the money for a long time, no people are willing to burn through the deal.