Investing in a startup, whether in the real estate market or somewhere else, is always an exciting time. It gives you the opportunity to not only make a significant return, but also contribute to creating a real change within an industry. In my experience, the latter is even more enticing than the former.
However, putting your capital into just any startup is not a smart decision. As an angel investor or a venture capitalist, it’s important to look at certain factors to determine if a company is worth investing in or not. Some of these considerations are more obvious than others.
Here are the six questions that will help you make an informed decision on whether a startup is worth it.
What Does the Startup Team Look Like?
I’ll never stop repeating that a company is only as good as its team, and that includes both management and employees. Therefore, the first thing to look at is a startup’s team.
Start from the top. Do the founders and the rest of the leadership team have what it takes to excel in the market? Are they knowledgeable enough about the industry? Are they committed to continuously learning all the time? Are they driven to succeed?
If the answer to any of these questions raises a red flag, simply move on and look for another opportunity. You cannot expect a successful investment if the company’s core team isn’t driving growth and disrupting their industry.
If the startup passes this initial set of questions, it’s time to look deeper into the team. Consider the current organization chart, the size of the team, the existing and missing positions, and whether this structure makes sense for the startup stage and aspirations. You should also evaluate individual employees to determine if they contribute to the bottom line in a meaningful way.
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Employee turnover at startups is notoriously high, at an average of 25%. This means that having the “wrong” employees is not the real problem, as a company can always replace them. The bigger concern, at least from an investor’s point of view, is that the absence of a solid team could indicate some major weaknesses on behalf of the founders and the managers. And this is something that is difficult to change over time.
After you have looked at the more technical and measurable aspects of the team, take some time to sit with the startup and have a heartfelt discussion. Remember: not everything can be evaluated through numbers and figures. Sometimes, important qualities – or lack of such – can transpire in a five-minute conversation with someone. And as you gather more and more experience as an investor, you’ll begin to learn how to judge character. So before deciding on whether to invest in a company, get to know the team and the company culture.
Does the Product Offer Real Value?
The second most important factor for the success of a startup – and your investment in it – is the value of the product. You don’t want to invest in a product that is only mimicking what dozens of other companies are already providing. You want to invest in a real gem with the potential to disrupt an industry. At the very minimum, the product has to offer a solution that is significantly better and more attractive than competitors.
That’s why I prefer to invest in industries that I am personally familiar with. For example, many of my investments are in the form of PropTech VC. Before investing in a startup, you need to be able to evaluate the uniqueness of their product and determine whether it’s solving a real industry problem. Also, consider its robustness, scalability, and market fit.
As an investor, the last thing you want is to put your money in a product with no future prospects.
What’s the Size of the Target Market?
Targeting a large potential market is just as important as having a real-value product. Even if a startup develops the best solution to an industry challenge, the organization can’t scale if the problem is only faced by a very specific niche.
To evaluate the potential market size accurately, you need to consider both the total addressable market and the serviceable available market. Moreover, you should calculate the share of the market that the startup can realistically capture through competitor analysis.
For this analysis, look at the market valuation conducted by the startup team and supplement this with your own analysis. While you want to trust the team you are about to invest in, it’s important to make sure that any numbers you are provided with are accurate and reasonable.
When choosing between investing in one startup or another, go for the one that faces a larger potential market—even if they are able to capture a smaller portion of it.
How Will Your Capital Be Used When Investing in a Startup?
The next big question to ask is how exactly your capital will be used by the company. The startup should have a specific plan on how they will spend every single dollar they receive from investors, and they should share this plan with you.
As an investor, you need to know whether your money will go toward product development, human resources, sales, or marketing. This company decision should be based on the needs of the startup, as well as the highest-potential areas.
Obtaining detailed information on how your investment will be utilized should put your mind at ease. In addition to knowing where your money will go, this assures you that the startup has a solid growth plan.
What Return on Investment Can You Expect and What’s the Timeframe?
Before moving forward with investing in a startup, you want to know what return you can expect and when you will start making a profit.
In this case, a major differentiator is whether the company is already profitable or still barely breaking even. It’s wise to invest in startups that already make a profit, no matter how small it is. This indicates that they have all the mechanisms in place to make more money than they spend, and now it’s just a matter of scaling up processes. That’s where your investment comes in.
Is There a Clear Exit Strategy in Place?
Last but not least, a startup that’s worth investing in is one with a strong exit strategy. It’s never too early to work on this plan. A solid startup will create an exit strategy in its early stages, as this will help drive all processes that relate to expansion and growth.
Whether a startup is working toward going public, an acquisition, a buyout, or some other strategy, you need to know when you can expect to get your investment back and in what form.
There’s no doubt that investing in a startup is an exciting process. It’s a surefire way to grow your capital while making a difference in an industry. However, that doesn’t mean you should make your investment decisions lightly. Instead, it’s smart to evaluate a company carefully to ensure that you’re investing in the best possible way. The next time you are thinking of investing in a startup, make sure to ask these six questions to maximize your chances of success.