Investing in startups offers a touch of excitement and a way to potentially get in on the ground floor of something huge. Before you go off throwing your money at something, however, you should know there’s a 90 percent chance of failure.
Mostly, that’s because many startups fail to execute their business plans well. If you don’t want to go down with those ships, then you’ll need to keep the following seven factors about startup investing in mind.
1. Your Understanding of the Industry and Customers
Before deciding on the types of startups that you wish to invest in, it’s important to learn something about the industry that you’re entering. Already have some familiarity with it? Good!
That will help you see the business plan and strategy of the startup in all its strengths and weaknesses. But if you don’t, you could be setting yourself up for disaster.
Take some time to learn the industry by understanding who its customers are. In our data-driven economy, we have more insights than ever into consumer behavior. Ask the startup founders what they have discovered about their ideal customers, and see how that compares to the industry as a whole.
2. Previous Successes or Background of the Players
The next part of your decision that is so important to your return on investment is the team itself. Who are these people behind the startup, and what makes them qualified to be doing what they’re doing?
As you explore this question, look at things such as background education, applicable grades in school, their histories as self-starters, and what, if any, businesses they’ve worked in or on in the past. Everyone makes mistakes, but red flags, such as losing money on another similar company, could keep you from sinking your investment before it has a chance to sail.
3. Any Relevant Assets or Financial Information
Every startup investment strategy can benefit from learning about the relevant assets and financial information regarding the business. If it’s still too new to have generated revenue or interest, then it might be too early to invest.
If you’d still like to give it a go, learn about what assets the company has in place, as well as things such as whether there has been a patent issued. Startups can be very valuable without initial sales, as long as you’re looking at the correct metrics.
4. Who You Are Going Up Against
An exciting idea with exciting personalities to implement can get you pumped to invest in a startup company. However, be careful to research the competition before moving forward. Some questions you might want to ask the startup founders are:
- How does what you do differ from your top competitor?
- What pain point does your product solve that hasn’t been solved before?
- What is your competitive advantage going up against older companies?
Additionally, you should do some product research on your own. Become a customer of the top competitor to see how they handle some of those same questions.
5. What the Startup Founders Are Asking For
If you are considering investing in a startup seriously, then you’ll need to see a business plan at some point. (The earlier, the better!)
A competent business plan will include detailed strategies and action items for the short- and long-terms. This should include items like how the company plans to market the product, where and for how much they will have it manufactured, how it will be distributed, and what it is they want from you.
Do they see you as an ongoing partner or board member who retains equity? Will they buy you out at a certain point, and for how much? These details should be settled at the outset, though they can always be renegotiated.
6. Your Own Risk Tolerance
Risk tolerance is something every investor must have to be successful. Furthermore, one should be aware of what that risk tolerance is and how to manage it. That’s not possible without an understanding of certain attributes, like your own available resources and how much passion and energy you plan on putting into the role of investor.
Are you just going to be there for the financial assistance, allowing the owners to run the business hands-free? Or, are they asking for your expertise and guidance as well? There is risk in both cases with which you’ll have to get comfortable.
7. The Actual Valuation
One number you’ll have to understand as you weigh the investment risks and rewards, is the actual valuation of the company. The most exciting idea that triggers your passions can be a bad idea if the business is overvalued.
Dr. Jasdeep Singh notes that finding the value of early-stage companies can be particularly challenging. He recommends looking at peer companies, assigning fixed values to the stage the business is in or calculating the cost to duplicate the business outright.
3 Ways to Invest
You now know the factors to consider when weighing an investment in a startup company. It’s time to figure out how to do it. There are three basic ways to invest in startups that consist of the following:
Get Plugged Into Your Community
Community business sectors will often host pitch events to encourage and aid young entrepreneurs in the development of their companies. If your area is currently hosting one of these, get involved. And if they’re not, consider rallying area business leaders around your efforts to do so.
Read Industry Lit
Industry magazines and websites are still great sources of information to see the hot industries as well as up-and-coming talent. Check in to publications’ websites daily to check with whom you might be able to connect.
Use an Investment App
It’s easier than ever to invest in a startup with the right platform, and you shouldn’t overlook the investment platform options that are out there. AngelList and Gust are two of the most well-known at this stage of the game, but there will probably be several more arise by the time you read this.
Investing in Startups Requires Research, Knowledge, and Passion
Investing in startups can be exciting because it puts you at ground zero for an exciting new business. It also allows you to help others make their dreams come true while making money in the process.
Do your homework before you invest, though, and then use the right strategy for getting started. For more entrepreneurship tips and articles, check out some of our additional posts!