Five Ways to Spot Top Private Companies

I like to ask company founders what keeps them up at night.

It’s a nonconfrontational way to find out what they feel a little unsure or insecure about.

One of these days, a founder will shoot back the question, “So, Andy, what keeps you up at night?”

Or maybe not.

It hasn’t happened yet. And, besides, I’m the one asking the questions in these conversations, not the founders.

But if YOU want to know what keeps me up at night, I’m happy to spill. It’s this chart…

In my nightmare, I invest in Startup A over Startup B. You can see why. Startup A has a revenue traction history that looks promising. Startup B has some initial sales.

So why is it such a nightmare? Well, when we extend the time horizon of the chart, it looks like this…

In other words, I blew it.

Startup B killed it. Became a unicorn. Gave its early investors 200X gains. I coulda, woulda, shoulda. But I didn’t.

This is what keeps me up at night.

The glib answer would be to invest in killer traction – Startup B and not Startup A.

But here’s the challenge of all seed-stage investors: It’s almost always too early to tell.

That Startup B company with the short but steep revenue curve? It was doing its seed round pre-traction.

It could just as easily have been an earlier iteration of the product (or business model) where the growth curve was much more gentle.

You could say the same thing either way. Nothing special to see here.

But many times, that’s not strictly true. There is something to see. But you have to look closely. And you have to have some idea of the early clues that point to possible killer traction before revenue takes off.

Here are five early clues to look for…

1. The market speaks. For example, a “smart home” company we have our eye on has a “problem.” Its early supply contracts with retailers (could also be with vendors and distributors) have had to be constantly revised upward. What I like about this clue is that it’s not about the brilliant marketing strategy or aggressive sales tactics of the founding team (no offense, Nayeem). It’s simply that customers love their product. The market is pulling sales, as opposed to the company pushing sales. It’s a great early sign that killer traction might not be far off.

2. Small effort, little spend, big results. Look at the chart again. Is the traction of Startup A achieved primarily by word of mouth (with little budget)? If so, you can reasonably expect a steeper curve when the company begins selling in earnest. Another scenario: Only the founder (who’s a tech guy) is taking sales calls, and he’s generating decent but not great revenue growth. It’s an interesting moment for investors and the founding team alike. The transition to a dedicated sales team isn’t always smooth. But the potential to spike sales is there.

3. Enthusiastic customer feedback. I’m talking about not just positive feedback, but the “OMG, this is better than I could ever have imagined” variety. My rule: A startup that has found 100 OMG customers is primed for serious revenue growth. For software-as-a-service companies, you look at net churn (how many people are signing up versus dropping out). For consumer product companies, you look at returns. For example, a startup on our radar has a return rate of under 1%, which is amazing.

4. Partnering with a ringer. We’ve seen startups enter into a commercial relationship with large companies and have their sales explode. But be careful here. We’ve also seen startups partner with powerful companies… and then? Nothing really happens. We have in our portfolio a VR company called Virtuix (we’ve told you about them). They recently captured two huge Chinese companies as partners. Our analysis of the agreements tells us these partnerships should have a huge impact on the company’s revenue projections going forward.

5. The Been-There Done-That Companies. Adam and I just added a company to our First Stage Investor portfolio that conquered a very competitive market in Europe. It has now set its sights on the U.S. market. Of course, the U.S. market will have its own unique challenges. But going to war in Europe and emerging victorious is one heck of a notch on its belt. This is a trend worth watching out for. We’ll be seeing more “victorious” startups in China, India and Europe targeting the U.S. These aren’t seed-stage companies. They have years of hard-won growth experience. The good news is that they’ll be increasingly available to crowd investors.

As an early investor, projecting revenue growth trajectory and ceiling isn’t easy. The thing is (and we’ve said this many times), you don’t have to be right all the time. You don’t even have to be right a majority of the time.

You just have to be right some of the time.

Say, one big hit for every 10 companies in your startup portfolio.

Very doable, especially when incorporating these five early clues to identify future off-the-charts revenue growth.

And for more information on how to get your start-up portfolio going, check out our Ultimate Guide to Pre-IPO Investing.

Invest early and well,

Andy Gordon

Founder, Early Investing