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Demos Parneros on What You Should Know Before Investing in Start-ups

So, let’s say you just heard about this new start-up company. It has caught your attention with its mission and potential, but you’re still on the fence about investing. What should you look for when making an investment decision about a start-up company? What factors should you weigh, and what are the pros and cons? Which risks should you avoid, and which ones are worth taking?

Every business is different. Sometimes long shots pay off, and sometimes sure bets go south. Every investment entails risk. But, from my experience, the most important factor you should focus on when making a decision is the founder and their team.

While important, the numbers, the branding, and even the product or service the company is providing are all secondary. At the core, the people, their skill sets, attitudes, and talents will make or break a start-up. A passionate leader with a great team can take a good business plan and make it great, while a less effective founder with an inconsistent team will have problems executing even a great business plan. Often, it’s less about what you do than how you do it.

But, let’s say you take that big pitch meeting with the start-up to learn more. Here are some basic questions you’ll want answers to:

1. Who is the founder?

This requires a deeper answer than just a name and a CV. You’ll want to know not just who came up with the idea or concept for the business but also why it is important to them, and what is driving them. What is their story? Is there a personal connection to their idea, and the importance of their business’s success?

How passionate are they about this business idea? This is important. Many start-ups are led by people who just want to last long enough to cash in. But every business runs into obstacles, every business struggles, and leadership that lacks passion will be looking to jump ship given the chance, leaving you and your investment behind. Passion and dedication are needed to pull through hard times, and start-ups are sure to run into hard times.

But while passion helps, more than that is needed. A successful future for a business requires people with deep knowledge of their subject matter and meaningful experience in their field. They have to get down to the nitty-gritty.

2. Let’s talk numbers.

Investors want to support new ideas and companies, certainly, but they also want to make money. So, it is important to review a start-up’s business plan closely. It can’t be a vague, sketched-out idea or outline. Drilled-down details are important because the plan must be watertight.

Business plans shouldn’t be limited to the short-term, there has to be a vision involved. It should explain the starting stages of the business, but also have solid predictions about growth, and how it can scale with realistic targets and timelines. Goals should be big, yet realistic. Additionally, the founders and leaders should have a plan for what they will do with the money they’ve raised, and how they plan to spend it.

A start-up’s business plan should include the following:

  • Analysis of their market niche and targeted customers
  • Review of all viable competitors within their market
  • Detailed financial projections
  • Marketing plans and a clear customer acquisition strategy
  • Potential issues, obstacles, and difficulties that may come up, and how to address them
  • A timeline for investors to begin seeing returns and profits

3. The idea or product.

The start-up world is crowded with companies trying to do something that either has already been done a million times or, even worse, doesn’t need to be done. The former means entering a crowded market while the latter means there’s no market at all. Before investing, ask if the start-up under consideration is actually a new and unique idea. Or show that their product will be in demand.

If the start-up can’t do that, be wary, but don’t give up. A company that can show its product creating a new market niche, or that the market itself isn’t saturated, is still worth a look. What competitive advantages does the business have? How good is the product? Even in a saturated market, a superior product can still win out.

4. The company mission.

While your main interest as an investor may be to eventually get a return on your money and make a profit, it is also worthwhile to support a product or idea that you believe in. Most start-ups will have a mission and value statement that can guide you. Decide if you agree with their vision. Is their product an important one? Does the possibility of this company changing the world excite you? Could it help people, or save lives? Maybe a slightly higher investing risk is worth it if the payoff is a better world.

What’s just as critical is if the company’s leadership believes in the mission. This goes to the necessity of passion mentioned above. If the founders and team can see beyond sales and growth to a greater goal, it can inspire greatness from top to bottom. Don’t underestimate the role of people’s hearts and fortitude in the success of a business.

5. Business structure.

Now we’re getting down to the nitty-gritty. Any serious company will have all of the parties’ contractual rights and obligations clearly assigned and delineated, and this includes you, the investor. An investor can have many different roles within a start-up, hands-on or hands-off. But it is crucial to have clarity before you start shaking hands.

As an investor, you should know if you are a partner or a shareholder if you have voting rights on important company decisions, and if the business structure allows for other parties to buy in later on. These facts should be clearly stated in your investor or stockholder’s agreement. It should also address the fallout from certain scenarios that might occur. For example: What happens if a project fails? What if the leadership decides to make major changes to the business plan? What if leadership needs to change?

The stockholder’s agreement should also include a clear evaluation of the business being invested in, which will provide an accurate representation of a company’s valuation and potential worth. This data is highly important, as, after all, you are essentially buying a piece of the business. You will need to decide the credibility of this information. Ask yourself, are the numbers real, or is the CEO indulging in wishful thinking?

This may involve a fair amount of negotiation, and a certain amount of back and forth is normal and expected. As long as all parties are satisfied with the agreement, then the partnership can really get started.

6. Review and accept the risks.

Any start-up CEO or investor guide should be able to walk you through the potential risks to the business and your investment. Expected risks can include legal or regulatory hurdles, potential liability (or the need to insure against it), issues with the quality of a product or service, and so on.

The founder should be able to rank these risks by likelihood and the level of damage they could potentially cause. In the end, you should be able to trust the team to handle any issues that may arise, now and in the future, and do so in a professional, timely manner.

The bottom line with risk is that you can lose all the money you invested. If you can’t live with that possibility, you should probably pass.  The founders and leaders of any start-up that you invest in should have skills, plans, and other assets at the ready to show you just how serious and passionate they are about the project. They should know the numbers, be clear about the mission, know their business plan by heart, and have the skills and experience to implement all of it. When a team is resourceful, competent, and driven, you should take note, because an investment opportunity likely awaits.

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