Seed investors are specialists in dealing with situations where uncertainty is prevalent. Their difficult task is to make investment decisions at a time when very few information is available and the future success very hard to predict. To be successful in this business, investors rely on sustainable criteria, which are more of qualitative than quantitative nature. The earlier an investment takes place, the more they focus on the quality of the management teams (personalities) and the quality of the business idea (unique selling proposition). A study, just published by SECA, investigates the decision criteria and valuation methods used by investors to assess start-ups. It is written by Lukas André who joined our team this March, supporting us as analyst in our projects.

In total 19 business angels and 15 venture capital firms participated in the study. Several common known hypotheses from literature have been proven with this sample: Business angels mainly invest their private money and limit their investment activities to early stages. On the other hand the venture capital funds focus on later stages and use third party funding. Due to the more professional environment of the fund managers, they were involved on average in about 15 deals, 5 deals more than a typical business angel. The average portfolio size of a venture capital firm consists of 21.5 investments. This is considerably more than the average of 7 portfolio companies by business angels. In addition to the more in depth experience, it shows the higher financial power of an average venture capital firm compared to a business angel. Venture capital firms indeed invest a considerable higher amount into a single project. While the typical business angel is limited to a maximum of about half a million Swiss francs per case, a venture capital fund can invest up to several million into one single project.

24 potential factors which might influence the investment decision by the investor have been identified for the study. The factors were grouped into "management / company", "product / technology", "market" and "cash-out potential".

Depending on the company stage, these factors are weighted differently. In the seed phase the "management" is seen as the most important factor. This group is valued highest with a weight of about 40%. While the company is developing the influence decreases. At buy-out it is valued with a total of 22%. Other factors gain more importance in exchange. The stake of the "cash out potential" increases from 10% to 31% while the categories "product / technology" and "market" are constantly valued in the range of 22% to 26% during the lifecycle of the investment.

Looking on single criteria in more detail it shows that venture capital firms are more interested in criteria which are directly linked to the financial potential. They are thinking more about the yield of an investment. Criteria like "exit possibilities", "market size", "growth potential of the market" are therefore valued significantly higher by venture capital firms than by business angels. However, other factors are important as well. Both investor types agree to rank "unique selling proposition", "motivation of management" and "personalities of management" at highest positions.

Differences between the two investor types have been identified as well in the application of valuation methods. A formal valuation of the company is much less important for business angels. A balanced shareholder structure between investors, founders and if needed employees outrank a very formal and correct valuation. These are the arguments they are using while negotiating the terms of a contract. Valuation methods are used less often by business angels than venture capital firms (1.89 times instead of 2.56 times) and are in average ranked lower.

With regards to the formal valuation, both investor types are in favour of market oriented approaches (similar transactions and multiples) followed by the venture capital method. Cash flow based approaches like the discounted cash flow method are ranked lower.
The methods presented as "methods by business angels practitioners" are not well known in Switzerland and are ranked very low in general. The main reason for this is the very fixed structure of the methods. Nevertheless, the ideas behind them are not strictly refused: similar considerations are used if an investor takes its experience as gut feeling into account for a specific decision.

If you are interested in the full study (in German) you can order it on the SECA website (SECA Booklet Nr. 2 – Bewertung und Selektion von Hightech-Start ups durch Venture Capital-Gesellschaften und Business Angel) or just contact us.