Deciding whether to invest in a startup is a complicated process, and the first time you meet a founder can be an intimidating situation…

There are mountains of documents to pore over – financial statements, tax forms, resumes, intellectual property, term sheets, business plans, and more…

Not to mention the fact that half the time, you’re trying to decide whether a product will be successful before it even exists.

It’s kind of like trying to nail jelly to a tree.

But, after several years and hundreds of founder meetings, I’ve managed to outline seven questions that do the job.

After all, “good on paper” isn’t enough in the startup investing world – I need something more to convince me.

We’re investing in people and their ideas. Here are the seven questions that’ll let you know whether a founder (and their idea) is worth your money.

1. Why are you doing this?

Why I like it: Open-ended questions force founders to paint me a bigger picture, allowing more of their personality to shine through. You’ll get an idea of what is important to this person. Plus, someone with a really great reason is more likely to see it through than someone whose idea happened at random.

A good answer: Starts with a personal story, and ends with conviction. The best ideas come from people who desperately want their product to exist. If it’s a real pain point for them, you can reasonably assume it’s important to other people, too.

Follow up with: Why are you the perfect person to execute this? And why right now?

2. How are you going to hit a massive audience?

Why I like it: This question will shed some light on two things: first, how large the customer base for this product could be; and second, how much thought the founders have put into marketing their idea. Do they have a plan to actually reach their customers? Is their assumption realistic?

A good answer is: As specific as possible, with a realistic and achievable marketing strategy that will get their product in front of massive numbers of people. Putting up billboards and buying radio ads is generic and underwhelming – look for answers that harness the latest tech and hottest media channels.

Follow up with: Who is your primary, secondary, and tertiary customer? How will you scale this business to appeal to a global audience?

3. What can you tell me about your competition?

Why I like it: Know thine enemy. This question turns up the heat. Any founder who thinks they don’t have any competitors is living in dreamland. Optimism may be good for business, but idealism is not. A successful business will have a “unique value proposition” – something that makes their product or service special – that allows them to stand alone.

A good answer is: Realistic, yet confident. Founders should know who all the other players in their space are, and have a plan in place to beat them.

Follow up with: What makes you different? Why will your product outsell theirs?

4. How is your business going to be capital-efficient?

Why I like it: This one is self-explanatory. I want to know how much money a company will need to spend as it grows. What will their margins look like as they take on more customers? A company that makes $10 million a year but spends $950,000 is really only making $50k.

A good answer: Includes a well thought-out plan to increase profit margins as the business scales. I avoid investing in companies that need to hire more people for every dollar they generate in revenue. Software, apps, and platforms are great examples of companies that scale well – their market cap is much higher, because distribution of software is dirt cheap.

Follow up with: What is your exit strategy? What milestones do you need to reach to achieve this?

5. What are the top 3 reasons you might fail?

Why I like it: Enough talk about exits – this question brings the conversation back to earth. There are thousands of reasons a startup might fail (that’s why more than half of them do). As Ben Franklin once said, “by failing to prepare, you are preparing to fail.” So what are the risks, and how will the founders avoid them?

A good answer: Doesn’t try to skirt around the issue. Good founders won’t need to grasp for straws here. They should be all too aware of the potential pitfalls ahead.

Follow up with: What is your contingency plan if each of these scenarios plays out?

6. What does each member of your team bring to the table?

Why I like it: Great ideas are everywhere. Great execution, not so much. Does this team cover all the bases needed to be a breakout success? This isn’t charity, so every person who stands to benefit from your investment better have a good reason to be there.

A good answer: Inspires confidence with a well-defined company structure. Every person should be properly qualified for their position. I don’t want to see someone with no accounting background shoehorned into the CFO position just to give them the benefit of a title.

Follow up with: Has this team worked together before? Has anyone on this team made successful exits in the past?

7. How did you determine your valuation?

Why I like it: It’s an unspoken truth that valuations are kind of bogus (more on that here). The same startup following different methods could arrive at numbers that are orders of magnitude apart. This question reveals the founders’ priorities. What component of their business do they ascribe the highest value to?

A good answer: Takes several factors into account, including market size, competition, and revenue growth. Valuation is far from an exact science, but I’m not impressed when the sole reasoning is, “App X sold for $50 million in a similar space, so App Z is worth the same.”

Follow up with: How far will this investment take you (in months)? What funding plans are on the horizon?

Some angels choose their investments based on intuition. Others are satisfied with a good idea. Many decide to invest immediately after seeing a pitch presentation, either out of excitement or fear of missing out.

Founders know this. Pitch presentations are all about hyping up the opportunity and playing to that fear.

In my opinion, you should never blindly trust a pitch deck. It’s the equivalent of a commercial for a startup; it aims to shed the best possible light on the business and leave its flaws in the dark.

Often, it takes a little digging to get to the heart of the company and its founders.

Running a business is hugely stressful, and requires a level of commitment and teamwork that many founding teams just don’t have.

Weeding out the incompetent, the unrealistic, and the inflexible is key to success.

That’s why I always seek the answers to these seven questions, even when the business looks perfect on paper.

If I’m satisfied with all seven answers, and my overall impression of the founders is good, then and only then do we begin to negotiate an investment.

See you next time,

Neil Patel


Comments

22 responses to “Exactly What You Need to Ask Your First Founder”

  1. Excellent recap of what questions you should ask as an investor. I’m viewing this from the entrepreneur’s view point of view with 5 companies of mine bundled together in a PRE-IPO offering. Check us out on Bloomberg. Worldwide Media Corporation or at my profile on LinkedIn.com under Ronnie Schmidt. Everyone who sees are offering is excited.

  2. Great questions! Especially the one asking about their competition. That is one aspect about traditional market research that should remain in this fast-forward version of business development. Asking the question forces the research – which may not otherwise be liked into as deeply. I also think a company should be required to have a documented “Contingency Plan”, so they are ready to address the “what if’s”. It shows some level of Risk Management for their Investors.

  3. I’m in the throws of a big move. I’ve just signed a year lease on a Brick & Mortar shop near VA Beach. I’m nearly 70 and off to realize my personal dreams & desire since I was a teen. My intention is to be a shopkeeper and not only create and sell my own arts & crafts but teach others so they can do the same. I believe it is part of my destiny. That said…I am a realist. Beyond wanting a blanket from the cold, a good sail for the voyage and a star to guide me through my journey I wish to have some buffer or safety in times of uncertainty. This will work, I think, for those future years! Thank you!

  4. For the novice investor like myself the 7 question q&a makes a lot of sense. It’s easy to be fooled by the CEO of a new startup because the focus is always going to be on best case scenarios presented to win you over. My basic position as a starting point is “does this business make sense to me” and is the CEO a B.S. artist.

  5. Re: Neil’s list of “What you need to ask your first Founder.”
    Point 4(of 7): Neil, you might want to check your math……..you write:
    “A company that makes $10 million a year but spends $950,000 is really only making $50k”. Actually they are making $10,050.000.
    Perhaps you might want to add an 8th point: It is very wise to hire a very good accountant to track your margins.
    Thanks for keeping us, the new Angels, updated.
    Bruce Wade

  6. My email Part 2: I sent an email earlier today re: Neil’s 4th point re:
    “How is your business going to be capital-efficient?”. Neil said if the company made $10M and its’ expenses were $950K, its profits would be
    $50k. I, light heartily corrected his math to read $10,050,000 in profits But after the fact I realized my math was wrong because the actual profits would have been $9,050,000.!! EarlierI suggested a new Founder might want to consider hiring a good accnt. I think I should also consider hiring a GREAT ACCOUNTANT!
    My apologies……….Bruce

  7. Thanks for the list. I just started not really sure what I was doing. Invested in 4 startups so far. Started watching all the videos and reading the different strategies Neil has posted. Excited about the future looking forward to see these companies strive.
    respectfully,
    Earl

  8. What are the steps in actually buying in and making payment for your choice of start up. will I get any paper work as to what I invested in. john where do I make my actual payment to.

  9. What are the steps in actually buying in and making payment for your choice of start up. will I get any paper work as to what I invested in. john where do I make my actual payment to. I am still lost.

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