A Growth Investor Checklist

Applying a common-sense practice of medicine and the military to the craft of investing.

Most investors believe they have good judgement (if they didn’t think that, they would have chosen a different profession). But good judgement is not infallible, and people with good judgement suffer all of the human vices — emotional swings, stress, bias — and human virtues — namely befriending a management team and losing perspective (also known as falling in love with your own deal). At its worst, a belief in your own good judgement can lead down a path of doing a deal because “it just feels right.”

As the Nobel Prize winning psychologist Daniel Kahnemann’s book, “Thinking, Fast and Slow” puts it, “Humans are incorrigibly inconsistent in making summary judgments of complex information. Decades worth of psychological studies show that people are extremely good at figuring out what information they need for a decision but do a poor job of using that evidence methodically over time drawing divergent conclusions from identical data on different occasions even when nothing fundamental has changed other than your mood, or the time of day, or other demands on your attention.”

A few years ago, The New Yorker profiled surgeon Atul Gawande and his use of standard checklists at the medical facility he was leading as a way to remedy the common failings of human minds. Of course, checklists are not a new phenomenon. The military has used them for some time, for example with jet and fighter aircraft. And in the private sector checklists are a common feature in the maintenance of complex equipment. Gawande’s innovation was to institute checklists in a setting where they had not been used or expected, and where the variability of different factors was much higher.

Dr. Gawande and his team started with a short checklist that covered basic procedures in a surgery (e.g., do we have enough blood and antibiotics?), as well as actions to facilitate good teamwork (e.g., does everyone in the Operating Room know the name of each person in the room?). They then tested these lists in eight different hospitals. The results were stunning. For example, when teams took the time to make peer introductions, the result was a 35% decline in deaths and complications related to surgery. Dr. Gawande turned his findings into a successful book The Checklist Manifesto: How to Get Things Right.

Although a growth equity investment does not have quite the same stakes as landing a jet or a life saving surgery, it can have much of the same complexity. An investment checklist helps to reduce common investment errors and avoid money losing decisions, as well as increase understanding of the key business and market factors that will contribute to a strong return.

The following are a few of the items on growth investment checklist.

General

• Do we understand what the Company does and can we explain it to others in plain language?
• Can we articulate our investment thesis in one or two sentences?
• Does the Company have a clear value proposition and ROI for its product(s) / solution(s)? What is it?
• Can we describe how its solution is “better-faster-cheaper” than existing or competitive offerings? Is this a long term advantage?
• Does the Company operate in a core sector where we have experience/insight?
• What is our investment edge and value-add?
• What are the risks that would cause us to face substantial dilution or loss of capital?
• What three to five things do we “need to believe” to make this investment?
• Will our investment be the last financing the Company needs? If not, are we prepared to invest more capital?

2) Valuation & Returns

• What are the valuation metrics for the deal and do they fall within acceptable ranges?
• How does valuation compare to similar transactions — recent M&A deals, public companies?
• Have we calculated an intrinsic value for the business (run a discounted cash flow or equivalent fundamental value calculation)?
• What is our investment or base case return? What is our probability weighted return?
• What revenue growth or profit growth would be required to hit these marks?
• At what price will we have our capital returned (inclusive of all debt, other payments and future dilution)?

3) Investment Structure

• How much are we investing? Primary component? Secondary component
• How much capital will be used for transaction related payments or debt payments?
• If there is secondary (a founder, senior employee or early investor) selling, do we know why?
• Are current investors participating in the round? Why not?
• What is the cap table, including options and other common share equivalents?
• What are the details for the previous financing rounds (dates, amount, structure, valuation)?
• What has management done with any previously invested capital?
• Is the option pool sufficient for the next twelve months? How much future option pool dilution do we anticipate over the course of the investment
• Does the Company have debt? How much? Under what terms/covenants?
• How much cash does the Company have on its balance sheet today?
• How much cash will it have post investment (payment of all expenses)?
• Do we have a liquidation preference? Is it senior to existing securities?
• Will our capital be "top of the stack"? If not, how much is on top of us?
• Do other investors have special rights that we do not?
• Do we have participation?
• Do we have dividends? Are they cash or PIK? Do they compound (daily, monthly, quarterly)? Do we keep them on conversion?
• What is our board representation – by number of seats? Is it proportional to our ownership?
• What major business & governance decisions require consensus? What decisions can we make on our own? What can we block?

5) Market

• Is the market opportunity a replacement of existing solutions or a new market?
• How large do we estimate the market to be?
• Are there Gartner, Forrester or other analyst reports on the sector and the Company?
• Who are the Company's top 3 competitors?
• How large are they?
• Are they venture or PE backed?
• How much funding have they raised?
• Why does the Company win or lose business to competition? Company view? Customer view? Analyst view?
• Has the Company been in a “bubble” industry over the last 5 years in terms of customer spend?
• Can we identify 2 – 3 natural buyers for the business? Has the Company had direct dialogue with any of these names (specifics)?

6) Customer Profile

• Have we called 10+ customers as references?
• Who is the decision maker at the customer who determines vendor of choice?
• Is this same individual responsible for procurement of the solution? If not, who is?
• Is the customer base diversified or concentrated?
• Is the customer base vertically focused?
• How sticky is the solution?
• Are there third party customer surveys / data? Net Promoter scores?

7) Product & Development

• How many products does the Company have? Are they sold as separate SKUs?
• What are the most recent release dates and maturity levels of each product?
• How many customers are using each product?
• What has been the customer count growth and sales growth of each product over TTM?
• Are there third party product reviews?
• What is the plan for product line enhancements?
• Are there new products or services scheduled to be offered? Timing/ dates?
• What is the process for gathering customer feedback and incorporating for product development?
• What are the engineering specs of the products (software language)?
• What is used for data exchange?
• What are the primary integration points into the customer’s infrastructure?
• What is the product line cost structure and profitability?
• Where is engineering / product development done?
• Who manages engineering?
• Who manages the data center operations?
• Where is the data center hosted? Is it redundant?
• Does the Company hold any patents?
• Does the Company own its core IP?

8) Services

• Does the Company offer services? What are they?
• Are they separately contracted?
• What are the payment terms?
• Has the Company met its services SLAs?
• How many customers are using its services?
• How many employees provide services?
• Does the Company utilize third party services providers?

9) Sales

• Do we have sales and marketing team overviews, including org structure, headcount, coverage?
• How is the sales force focused? By vertical? By geo? By product? By channel?
• How many quota-carrying vs. non-carrying sales employees are at the Company?
• How many employees met or exceeded quota last quarter? Last twelve months?
• What is the average productivity per salesperson (percentage quota attainment)?
• How long (months) does it take a sales person to be productive based on actual data (time of hire to reach quota)?
• How many new sales hires have been made recently? How many are planned to be made?
• What is a new sales hire profile?
• Do these figures support the sales plan based on historic productivity?
• Does sales have a qualification standard, e.g., BANT, NUTMEG?
• What is the number / ratio of sales qualified leads required to make a sale?
• What are the stages of the sales pipeline?
• What are the conversion rates from stage-to-stage?
• What is the current sales pipeline by stage?
• What was the sales pipeline one year ago by stage, if available?
• What software applications are used to track sales?
• Do we have a data sheet with key sales metrics for past six quarters, including historical quarterly gross sales pipeline snapshots segmented by — Expected close date, Stage / Likelihood of closing, New vs. upsell, Service / Product
• Do we have current pipeline with the same detail as above
• Do we have a data sheet with the historical quarterly quota and attainment by sales rep with rep hire dates (any notes on rep ramp expectations, e.g. only expect a rep to be at 20% of quarterly quota in first quarter)?
• What has been the historical win/loss information on recent deals?

10) Marketing

• How does the Company price its products?
• Has the Company successfully raised prices?
• Has the Company been forced to cut prices in the last 24 months?
• What is the “ideal customer” profile? Is this defined in writing?
• Are the customer “buyer personas” defined in writing?
• What marketing programs does the Company use to reach its target audience?
• How does it measure success of those programs?
• What defines a qualified lead?
• How many marketing qualified leads (MQLs) are required to generate a sale?
• What has been the growth of marketing qualified leads over time?
• What is the current state of the marketing funnel?
• Do we have data on the leading sales indicators trended monthly for past 1 – 2 years, including: new raw leads (e.g., inquiries), MQLs, SQLs and opps by source (e.g., partner referral, customer referral, event, website, inbound call, etc.)?
• When does a lead become an MQL or SQL? What has been the relative efficacy/conversion rates?
• What systems are used to track the marketing funnel?
• What is the ratio of total marketing spend to change in revenue? TTM? Last Quarter?
• What is the Company’s share of its Total Addressable Market (TAM)?

11) Management & Administrative

• Is the Company lead by a strong CEO?
• How long has the CEO been at the Company?
• Are the founders involved with the Company? In what capacities?
• How long have the other key management members been at the company? Worked together?
• Are the key executive functions in place? If not, where are the gaps?
• Have we run a background checks? Any red flags?
• Have we called management references – personal and business? Our own and not just management provided?
• How many offices does the Company have?
• Where are the employees and senior management located?
• How much attrition has there been in past year?
• Is management’s shareholding > 20%?
• What are management’s equity incentives? Amount, type and vesting periods?
• Does senior management have a cash bonus plan? What are targets?
• What are the salaries for the senior management team?
• Does the management team have employment and confidentiality contracts in place?
• Does the Company conduct employee surveys – what are the results?
• Do employees understand the (1) the mission of the business; (2) the key priorities of the business? Have we validated this by interviewing non-management employees?

12) Governance & Legal

• Does the Company produce board and oversight materials?
• Monthly flash reports
• Monthly budgets and board decks
• Quarterly board decks
• Annual budgets
• Annual operating plan with goals & objectives
• Have we reviewed the Company's board decks, reports and minutes for the last two years?
• Have we reviewed the documentation from earlier investment rounds?
• Have we reviewed any bank or loan documents?
• Have we reviewed lease agreements?
• Have we reviewed management and employee contracts?
• Have all employees signed an appropriate Confidentiality Agreement, also covering IP?
• Are there any red flags that call into question the Company's integrity?

13) SaaS Economics (if appropriate)

• Does the Company sell recurring contracts? What type?
• Are these contracts annual, multi-year or monthly contracts?
• When is cash received from those contracts?
• What is the current month’s recurring revenue?
• How many contracts does the company currently have?
• What is the churn – by contracted number of customers?
• What are the retention rates and the churn rate – by contracted dollar volume?
• Do individual customer contracts expand or contract over time?
• What is the customer lifetime value (CLV)? How is it calculated? Have any customers actually used the product for this assumed period of time?
• What is the customer acquisition cost (CAC)? How is it calculated?
• What is the ratio of CLV to CAC?

14) Additional Financials

• What is the Company’s financial history?
• Last three years by year?
• Last two years by quarter?
• Last year by month?
• Has the business met or exceeded or fallen short of the projections they have provided?
• Have we developed our own projections for the business for this and the next calendar year?
• Did the business show growth in Revenue Per Employee? Revenue Per Share?
• Have expenses expanded at the same rate, higher rate or lower rate as revenue? As income?
• Has the business been audited? For how long?
• Have we spoken to the auditors? Any issues? Red flags?
• Do we have monthly P&L, Balance Sheet, and Cash Flow Statements for past two years?
• Billings, ACV Bookings and Revenue by type (consulting fees, retainers)
• Cost Centers (sales, marketing, facilities, administrative)
• Headcount and salary data
• Quarterly GAAP model with key drivers for remainder of 2017
• Discussion of revenue recognition policies and other major accounting policies (e.g., R&D capitalization)
• Do we have the most recent capitalization table, including option pool schedule (employee, position, grant date, total options, total vested, strike price, as well as any performance related options)
• What percentage of the Company’s revenues are structured as recurring contracts?
• What percentage of the Company’s customer base renewed its contracts over TTM / LFY?
• What is the Company’s gross margin? Is it stable?
• Is the Company EBITDA positive? If not, will it be EBITDA positive within the six quarters post investment (next eighteen months)?
• What are the “adjustments” in adjusted EBITDA? Do they fit our model?
• What is the Company’s free cash flow? Ratio of FCF to EBITDA?
• Is the Company bootstrapped?
• Is the business capital intensive? What was capex spending in the last year?

15) M&A

• Has the Company done any M&A transactions?
• Do we have detail on acquisitions and investments to date?
• Transaction terms and structure
• Target financials
• Valuation at time of investment (TTM, NTM)
• Source of Transaction
• Financing source(s) and terms of financing