How investors evaluate founder risk

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1995

When an investor evaluates a company , he thinks about all the possible risks which could cause the company to implode, so that he can try to minimize them. Risks would include things like product risk; technical risk; market risk; and competition risk. These are fairly standard in any framework which investors use to evaluate a company.

However, there’s one more risk which is far more important in a startup, and that is founder risk. Can you trust the founder? The reality is that every investment in a startup is a bet on the jockey , not the horse. The problem is that it’s extremely difficult to evaluate the ability of a founder to run the company. How mature is he? Is he frugal ? Can he lead from the front ? Can he manage well ? Is he responsible ? Is he responsive ? Is he aware of his shortcomings ? Will he listen to coaching? Is he a hustler? How much skin in the game does he have?

A of entrepreneurs are extremely smart; technically very accomplished; have done very well academically ; and are charismatic. But the key question which an investor needs to ask is, “Will he be able to run the business?” Does he understand finances? Does he understand that everything takes twice as long as you think it would be? Is he excessively optimistic or is he capable of dealing with all the hurdles which real life is going to throw at him?”

The difference between a successful angel investor and an unsuccessful one is his ability to evaluate how well the founder will respond in a crisis. Will he try to hide the truth ? Will he try to cover up? Or will he be mature enough to reach out for help in order to be able to tide over the crisis?

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It’s very hard to be able to answer these questions in advance, and this is what makes angel investing such a dicey proposition !

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