• Brandminds 2020

How to evaluate a startup company for investment -
5 tips

If you are an investor looking for a startup company to invest in, this article is for you.

It is no secret that investors have a hard time finding good investments. With large sums at stake and a constantly shifting market, investors that do not try their best to avoid miscalculations will experience a loss of capital. Beyond the initial difficulty of finding a credible source of startups to invest in and how to go about it, the biggest question investors ask themselves is “how do I know this investment is right?”.

Indeed, how does anyone know if their decision is the right one or not? There are certain indicators that allow seasoned investors to avoid making such costly errors. While some investors simply follow their gut, the majority are certainly much keener to do (extensive) research before making any decision.

Blindly trusting what is presented to you when it comes to investments is, to say the least, unwise, especially when considering that up to 90% of startups fail, and of those that do succeed, many take a long time to see profit. For most investors, this small and far-off goal does not produce significant enough ROI to mitigate the risks involved in the first place.

As such, investors need to be completely sure before they make the investment.

The question of how to evaluate these startups

Fortunately for you, there are several ways in which this can be done. Don’t be afraid to ask your prospective the tough questions, remember, it is your money on the line. Startups require capital, and as competition for investors is cut-throat, they are willing to provide all the information an investor may need.

Following these 5 tips could be the difference between making money and losing what you thought was a sure-shot investment.

1. The Founding Team

The world’s best investment companies are the ones that are extremely selective in the startups they invest in. Those chosen startups have only attained such investment through the perseverance of a strong team. A strong founding team is the first thing an investor should look at when considering a startup.

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The leadership of a startup forms the culture, discipline and work ethic of that venture. While a new or innovative concept will be necessary to win over customers, it cannot be denied that the hard work of the founding team directly correlates with the success of the firm. The way the idea or business model grows and develops depends on the core team that starts it all.

As an investor, you have to look for the passion of the team as much as the integrity of the project. Teamwork is also an important factor determining how well the startup functions. Beyond this, how experienced are the founders? Are they new to business in general, or have they already owned or operated successful businesses? This is a qualitative measure of how likely a startup is going to be successful before they have even launched.

2. The overall returns on the investment

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During pitch presentations, make sure you ask the startups for accurate projections of annual revenues and profits, implying the kind of return on investment (ROI) you can expect. Many startups are unrealistic about their expected returns because they are trying to please potential investors.

Instead, make sure to do your research and request the company’s previous balance statements. You’ll be able to catch all the overpromises they have made due to inexperience easily.

Investors, however, should not let a lower ROI be the reason they reject a startup, as this must be judged on a case by case basis. A pragmatic approach means that the ROI you are presented with will be closer to the one you receive. As an investor, you also accept that even for a successful startup, ROI starts out small and grows gradually over time. If spent correctly, the investment will allow the startup to expand, leading to greater returns in the long run.

3. The competitive advantage of the investment

Investors often worry about the idea that a startup has immense competition in the market. They often forget that this means the startup has potential as they have tapped a potential market segment. On the other end, other investors also tend to look out for promising startups so they could get their hands on them first.

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Competition to invest in a startup only raises its credibility as a desirable investment opportunity. Since startups sign a contract for a set number of years, the investors would benefit from them until the contract is renewed or turns void.

A venture should not be avoided just because a high degree of competition restricts its entry into the market. Instead, investors should have a more flexible approach, and potentially allow new ventures the chance to carve their own paths. Several companies have risen to prominence by virtue of the fact that their investors had faith in the company’s capability.

4. Market momentum and demand

The product’s position in the market is a strong indicator for investors. Companies have to build a certain momentum within the market in order to attract investors. This momentum can be crucial because it helps drive the company to the next level.

The job of an investor is to determine whether the next level is achievable with their help. If achieved, the company will not only evolve and produce substantial ROI for the investor but establish itself in the market. If however, the company fails to do this, the investor might lose out because of a bad deal.

Check the overall growth of the company and how it has built itself to the point that its founders are pitching to you.

Check through past financial reports and even ask for profit and loss statements to see overall growth.

The kind of momentum built in the market is itself a key performance indicator of how well the company is to perform in the years to come.

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5. Business mission and values

The mission is the one thing that the investor cannot change. For an investor, it is the mission of the company that can make the final decision. Some investors can be so impressed by a venture’s mission that they may go with the investment blindly, yet these are rare exceptions and is in general not recommended.

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The mission the venture puts forward will also inform the culture of the startup. The investor, therefore, has to determine whether the mission aligns with their beliefs. Startups usually describe their mission in their pitch, though if they fail to do so, ask. Failing to mention the business mission is one of the most common mistakes made by rookie startup CEOs, and it is important when making your decision.

The way they speak about it speaks to the emotional value the company’s owners stake in their business. An entrepreneur who is highly emotionally attached to the mission is likely to devote more of their time and energy to the project, and this should be considered when determining whether the startup is worth taking the risk for.

Be aware, however, that a passionate entrepreneur can also be a stubborn one. Make sure the culture of the startup is in line with your own belief system. Having clashes after the deal is done can prove to be harmful to both parties.

Taylor Ryan (CMO@Valuer.ai) writes about 5 tips on how to evaluate a startup company for investment Click To Tweet

Why invest in a startup?

Startups are full of energy and potential that can greatly benefit from a little injection of money. Investors often look for promising startups in schools, competitions and online because they recognize the kind of potential they have to drive change in the market. They are capable of disruptive innovation, thereby changing the overall landscape of the market, as Apple once did.

Investors are always on the lookout for promising entrepreneurs with their own companies who display the kind of leadership qualities that can create success. Startups are also a great way of investing in something with the potential for huge returns.

Key Takeaways

  • Is the founding team strong?;
  • Look for the passion of the team as much as the integrity of the project;
  • Request the company’s previous balance statements;
  • Judge a lower ROI on a case by case basis;
  • A startup with competition in the market means they have tapped a potential market segment;
  • Determine whether the startup’s next level is achievable with your help;
  • Check the overall growth of the company;
  • The kind of momentum built in the market is itself a key performance indicator;
  • What is their mission?
  • The mission will also inform the culture of the startup;
  • Does the founding team have an emotional stake in their business?

Conclusion

Evaluation of a startup is a necessity, as you can never be sure what the startup will bring to their pitch. The business can thrive with the investors help or equally drown in debt in a few years. No matter what happens, an investment is never 100% guaranteed. An investor is always gambling on whether or not an investment will work out.

Investing in startups might not see an immediate ROI, but can be extremely profitable in the long-run. Some of the greatest investors of all time started by investing in small startups that at that time were only worth a couple of hundred dollars. Now, companies like Apple, KFC and even Google are worth a million times more than their initial evaluations.

In time, the kind of qualities that you evaluate the company on will reap the fruits you deserve. The rest requires patience and hope that whatever happens, happens for the better.

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