As a startup seeking funding from investors, it's crucial to understand the key elements of the startup evaluation process and be well-prepared before meeting with investors for a potential investment opportunity. Venture capital investors are constantly on the lookout for promising startups that have the potential to disrupt industries and generate significant returns.

However, evaluating investment opportunities can be a complex and challenging process that requires a careful analysis of various factors. In this blog post, we will explore how venture capital investors like ourselves evaluate startup investment opportunities.

Market Opportunity

One of the first things that VC investors look at when evaluating a startup is the market opportunity. Is the startup addressing a large, growing market that is ripe for disruption? Is there a clear need for the product or service that the startup is offering? If the answer to these questions is yes, then the startup has the potential to attract a significant market share, which is an attractive prospect for investors.

Kinfolk seeks out businesses with the potential to become leaders in their respective industries in Africa and on a global scale. To assess this potential, we ask a key question of all potential investments and portfolio companies: can this business achieve $100 million in annual revenue within the next five to seven years? This is a shorthand way of evaluating whether a business has the scalability and growth potential to become a significant player in its industry, both locally and globally.

Once we receive an affirmative answer to this question, we proceed to conduct a more in-depth market evaluation. This involves extensive research into a startup's chosen market, including its size and growth rate. We also evaluate the competitive landscape to determine the level of competition in the market and the startup's potential to capture market share. Additionally, we assess the target customer segment to determine whether the startup has a clear understanding of their audience's needs and preferences.

We also analyze the startup's unique value proposition to determine whether the product or service offering stands out from the competition. Lastly, we consider the barriers to entry for new competitors in the market and the likelihood of new competitors entering and diluting the startup's market share.

A key element of Kinfolk’s investment model is our commitment to building strong, long-term partnerships with the startups we invest in, and working together to achieve mutual success. Through this comprehensive evaluation process, we not only assess a business's potential for significant growth and industry leadership, but we also position ourselves as value-add investors who can better support and partner with our startups. This allows us to provide more strategic guidance and resources that can help drive growth and maximize the potential for success.

Quality of Management

The management team is another critical factor that venture capital investors evaluate when considering an investment opportunity. They assess whether the team has the necessary skills, experience, vision, and commitment to execute on the business plan and lead the company to success. Additionally, investors look for a strong track record of success and a clear understanding of the market and the competitive landscape.

Kinfolk understands the underlying psychological mindsets of each individual leader are the first and often most critical aspect of evaluating a company's management team. This enables us to anticipate who is likely to exhibit results-focused, systems-thinking, and ethical behaviour in entrepreneurial settings across Africa, which is often associated with the creation of enduring and transformative businesses, as well as breakthrough innovation outcomes.

After gaining comfort with the underlying mindset of a company's key leadership, we conduct a deeper evaluation of the management team. We assess whether the team has relevant industry experience and a track record of success, as well as leadership skills, such as the ability to manage people, make tough decisions, and communicate effectively.

In addition, we evaluate the team's composition for a balance of complementary skills, including critical areas such as technology, go-to-market, finance, and data analytics, as well as diverse perspectives, experiences, and mindsets. Like other investors in the venture capital industry, we also look for a team that can execute the business plan and has a proven ability to meet milestones and deliver results.

Lastly, we assess the passion and commitment of the management team towards the product or service offering and their ability to persevere and overcome challenges that may arise.

With our long-term investment horizon in mind, we also view the leaders in our portfolio as a collaborative community of individuals who are dedicated to the mission of transforming the social and economic landscape of Africa and its diaspora. As such, we actively seek to attract founders to our Kinfolk who embody a leadership approach that we believe is critical to driving transformative change in African society - servant leadership.

Servant leadership prioritizes the needs of others and emphasizes collaboration, empathy, ethical decision-making, self-awareness, commitment to self-improvement, and humility. We believe that by fostering a community of servant leaders, we can inspire positive change and drive sustainable development in the region.

Product and Technology

When evaluating the product risk of a startup, venture investors consider several factors, including the uniqueness of the product, the size of the market, the level of competition, and the stage of development of the product. Primarily, however, they assess the extent to which the product meets a clear need or solves a problem for customers, as well as the potential for the product to gain market acceptance and achieve significant market penetration.

When evaluating a startup's product viability at Kinfolk, we ask a key question: "How sticky is this product?" To help answer this question, we rely on an important metric - the user retention rate. This metric measures the percentage of users who continue to use the product over a specific period of time, and a high retention rate indicates that the product is delivering value and satisfying users. This, in turn, can lead to increased revenue and growth for the business. Conversely, a low retention rate can suggest that the product is not meeting user needs or has underlying issues that need to be addressed.

At Kinfolk, we believe that the best companies in the world constantly enhance user experience and increase customer loyalty by promoting data-driven decision-making in product development and marketing. One way we encourage this is by recommending startups to invest early in using product analytics tools and platforms like Google Analytics, Mixpanel, Heap, Segment, Firebase, and others.

Once we determine the stickiness of a product, we conduct a deeper evaluation of the underlying technology stack. The objective of technology diligence is to identify potential risks and opportunities associated with the startup's technology stack and to determine whether it aligns with the company's strategic goals and business objectives.

We conduct technology diligence by reviewing the software architecture, code quality, and other technical documentation provided by the startup to gain insights into the development process, technology stack in use, and potential platform dependencies and risks that need to be considered.

Additionally, we speak with the startup's technical team, including developers, architects, and engineers to understand the technical decision-making process and to assess the team's technical and problem-solving capabilities. We also use external benchmarking to compare the startup's technology stack with those of industry leaders, similar companies, and even direct competitors to evaluate the startup's competitiveness and market position. Finally, we evaluate the scalability of the technology stack to handle increased demand and future growth.

At Kinfolk, we have built our company from the ground up with a technology company approach, which allows us to evaluate not only the product and technical aspects of our current and potential portfolio companies but also to understand the lifecycle of product and technology creation. Our experience as fellow technology product-builders enables us to better empathize and collaborate with the startups we invest in, serving as expert advisors and technologists alongside them.

Traction and Execution

When assessing a startup's traction, VCs typically look for a combination of quantitative and financial metrics such as user growth, revenue, expanding margins, user engagement, lower churn rates, customer acquisition cost, increasing customer lifetime value, burn rate, and cash runway.

VCs also look for qualitative evidence of early market validation, such as positive user feedback, early adopters' enthusiasm, and successful pilots or partnerships with other companies. We at Kinfolk ask the core question, “Does the present data suggest that this company can achieve profitability in the long run?”

However, we are also aware that early-stage companies often struggle to generate meaningful traction data without additional capital funding. At Kinfolk, we primarily focus on investing in the seed stage, sometimes even before the business has fully generated traction and taken shape.

In such cases where traction data is limited, we evaluate a company's ability to translate its business model into specific operational plans and activities that can be executed by the team. We assess the leadership's ability to define short and long-term objectives, key results, and KPIs to measure success. We also evaluate the company's go-to-market strategy, and ability to identify target markets and develop a repeatable plan to acquire customers.

Additionally, we examine the company's infrastructure and systems for measuring performance in delivering the product or service to customers and managing its relationships with suppliers. We also assess the leadership's ability to attract, hire, and onboard the right people with the necessary skills and experience. Lastly, we evaluate how well the team has used its meagre historical data to monitor and optimize performance with limited resources.

Valuation

When a venture capitalist evaluates a startup, the company's valuation is the final factor to consider. Ideally, the evaluation process conducted by a VC builds up to a proposal of investment in which the VC offers to purchase a share of the company at a particular price. The final valuation is negotiated between the VC and the startup management, taking into account various factors such as capital market conditions, risks inherent in the company, personal relationships, and other relevant considerations.

At Kinfolk, when we assess a company's valuation, we ask two primary questions: how will the company generate an exit to provide investors with a return on their investment, and what is the likelihood of that exit happening? To answer these questions, we carry out a comparable company analysis where we compare the startup to similar public companies in the industry and use market multiples to determine its value at its current scale.

In addition, we use internal scorecards to gauge the probability of an exit by evaluating different aspects of the company, such as the quality of the management team, market size, product quality, competitive advantage, and more. Based on this evaluation, we arrive at an estimate of the company's probability of growing to a scale that will provide a substantial liquidity event for investors.

It's crucial to bear in mind that investors expect compensation for the risk they take on, and as a result, a company's valuation should be reasonable and reflect the risk an investor faces. The failure rate for startups is high, with approximately 90% of them failing. Within the first year, 10% of startups fail, with similar failure rates observed across all industries.

Most startups fail during years two through five, with 70% falling into this category. As a result, if a startup's leadership wants to enhance their company's valuation, they must demonstrate to investors that they have already or will have the ability in the future to reduce the risk of failure.