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What Makes a Good Startup Investment?

The 8 questions any investor must ask in order to assess risk and increase chances for success.

As an investor, you are passionate about innovative ideas, and by funding them you participate in the world’s ongoing progress and advancement. In that sense, investing is much more than profit-driven. It is also a calling for building out the businesses that could change the future. 

One sure thing is that startup investing is not for the faint of heart. Where there is potential reward there is risk, and the decision to put a significant sum of money on the line requires serious thought. Decision-making can be even more challenging these days because there are more startups than ever before competing for your interest. The literal million dollar question is: How to assess if a venture is a suitable investment opportunity?

If looking for promising new ventures to fund, you’re probably familiar with different types of startup investing platforms for VCs and business angels. Here on Qilindo, you have free access to a fast-growing network of carefully selected startups, with the full liberty to connect and conduct business partnerships on your terms. 

Since our main goal is to help make more successful deals happen, we make every effort to pass on useful knowledge and valuable advice that both new and more experienced investors can benefit from. Therefore, let’s take a few minutes to break down the 8 most important factors we believe you should consider when evaluating whether or not a startup is a good investment.

Things You Should Already Know Before Investing in Any Startup

All new ventures – even those which develop into unicorns – carry some risks. Any VC angel investor also understands that success is simply impossible to guarantee, even if everything seems well aligned for it. 

According to research, the average failure rate for a venture fund portfolio is between 40% to 50% in a given year. Furthermore, the majority of newly established companies end up failing to meet high expectations, with nearly 90% of them not making it to IPO. Investors always go in knowing from the get-go that they may not get the high returns they hoped for.

Looking at it from a different angle, the reality is not so grim. If the number of unsuccessful startups seems like a lot, consider that 90% means at least 1/10 of startup investments are likely to succeed. Adding on, let’s suppose the company doesn’t make it to IPO, it could still be acquired by a bigger corporation. These payoffs normally outsize any losses by far. Otherwise, who would continue to invest in this world? In fact, now is a great time to invest in startups, with research showing that propitious angel portfolios can generate returns of over 2.5 times over a 4-year period.

The other good news is you can mitigate risks and pick the right startup to invest in by knowing what questions to ask and what answers to look for. 

8 Key Considerations for Assessing Which Startup to Invest In

Unlike more established companies, startups rarely have a history of sales, profits, or cash flow which can be used to measure their value fairly and reliably. This means you have to work a little harder to properly get inside the business, digging relevant information to evaluate if the opportunity is right. Put careful consideration into the following aspects to obtain the insight you need.

  1. How large is the market? 

The addressable market should be big, typically one that can generate at least 9 figures per year in revenue. The bigger the market size, the greater the likelihood of a trade sale, and the greater your odds of receiving large returns. You should expect the business plan to present a detailed market size analysis including third-party estimates found in market research reports. Make sure the analysis defines the Serviceable Obtainable Market (SOM), as this accounts for competition, trends, market demand forecasting, distribution channels, and other factors defining what your realistic market share is. The SOM is the first portion of the market the product/service must penetrate, making it your short-term target and risk mitigator. If the company can demonstrate its ability to penetrate the local market before all else, you will largely lessen the risk of losing your investment. When the company reaches its SOM, you can go after higher rewards by reaching a more important penetration of the Serviceable Available Market (SAM). 

  1. Is the product or service validated by consumers?

It’s one thing to demonstrate theoretically that there is a large viable market for the product or service, it’s another to prove that actual consumers are ready to spend their money for it. Does the company only have a proof of concept, or does it also have a prototype or beta version being tested? Have focus groups been conducted? Feedback from real potential customers that shows their willingness to pay for the product or service is a very good sign of a promising company to invest in.

  1. Is there a solid go-to-market strategy?

Following the market size analysis, assess how the product or service is being marketed to the consumer. A great idea can fail if the marketing is misguided. For example, the founder of a new electric vehicle may be very committed to clean energy and presume that consumers will buy in because it is the right thing to do – but the reality is they will do the right thing only if it is also competitively priced and provides added value. The strategy should explain what the process to get to market is, and how well it actually understands the pain points, trends, and behavior of the target audience. 

  1. Is the company scalable?

If the product or service is inexpensive to make and sell, the company can build a strong margin and increase revenue quickly. A company that is scalable can increase its customer base without proportionally increasing the production cost, which means it becomes more profitable as it grows and that it could yield major returns. Oppositely, a product or service that requires a lot of expert personnel, customization, installation, or consultation is not appropriate for scaling up. To fulfill the needs of a large market a scalable business model is necessary. We recommend asking to see a product roadmap that spells out realistic costs of production and delivery.

  1. Does the product or service offer a strong competitive edge?

Make sure that the product or service offers a solution to a real problem that hasn’t been solved by other companies. Consider the USP (Unique Selling Proposition), how does it stack up against competitors? A promising startup has an X-Factor that gives them a long-lasting competitive advantage, usually because their product or service is superior and/or cheaper than anything else like it in the marketplace. 

It could take a funded startup 7-10 years to exit, so think forward: Will this be the right product or service in 10 years from now? For example, if the startup is improving features that would be rather easy for competitors to surpass, it may be a little risky to invest, especially if various companies are already operating in the same space. 

  1. Does the potential exit provide the return needed?

It is essential to plan an exit strategy from the start and to calculate what you could get out of the eventual exit. The variables in this equation are: the investment amount, the pre-money valuation, how much equity you own, and the estimated acquisition purchase price. This is why you want to understand who is likely to be interested in purchasing the company, why these potential acquirers would be interested, and an expected timeline to acquisition. 

Be mindful not to focus only on how much the company might be sold for. Also inquire whether additional investment rounds will be needed since the stock percentage you own for the money you invested could possibly be diluted. If a company is not likely to require a lot of additional funding, you can increase your chances for a higher return and more easily gauge how much the company has to be acquired for in order to reach your goal – and when you lessen guessing you also decrease risk.

  1. Does it help diversify your portfolio? 

The well-known expression “don’t put all your eggs in one basket” also applies in startup investing. There is no need to wander way out of your comfort zone if just like many investors you prefer to stay within the industry of your expertise – You can still invest in companies developing products or services that target different demographics and markets, or even in startups which are at different development stages. 

The general consensus is that diversifying your portfolio can reduce the risk of losing big and maximize your potential returns because the more you spread your investments out across many companies, the more likely you are to hit a home run that would offset other losses. Determine whether or not a venture opportunity also helps you build a more diversified portfolio before you decide to invest in it.

  1. Invest in the people, not only the product.

This aspect is not to be taken lightly! Any startup, no matter how amazing the product or service is, needs solid management behind it. Many experienced investors say it is the most important factor to take into consideration. The management team plays a central role in the company’s development by committing their skills to execute the business plan, but also by helping build culture and connections as the company grows. If you are looking into a startup founded by first-time entrepreneurs, you’ll be glad if there are experienced insiders and senior advisors with a proven track record.

If the startup you are looking into can cover all the bases listed above, you can proceed to the next step. It might take some time and effort to pull all this information together and vet the company, but this is absolutely necessary for anyone who wants to invest in startups and ensure the highest success rate.

The Bottom Line

Evaluating risks and knowing how to minimize them to maximize your ROI is at the heart of every business decision. There is no play-by-play rulebook, but with some wise starting advice and experience accumulated over time, one will become savvier and develop a greater ability to choose the right startup investment opportunities. Every angel is unique, and building your investment strategy is a process such that every investor will develop their own approach and preferences. Different investors may place more importance on certain qualities over others. Some highly consider factors like location, growth stage, or the amount of capital needed to secure the venture. The better you get to know your preferences and what types of deals match them, the better your decisions will be.

In all cases, remember to practice due diligence. When you find a startup that aligns with your preferences, check financial records as this will help you to see if numbers add up with the valuation you based your investment on. Remember that legal, regulatory, and compliance issues are also important to consider for brand new ideas. Meet the management team, learn more about the founders, take the time necessary to conduct sufficient research and arrive at a well-informed decision.

Find stellar startups to invest in

Now that you have best practice recommendations to guide you, try to seek out as many good opportunities as you can. Studies have found that angel investors should have around 15-20 active investments at any given moment if their goal is to achieve a yearly annual return rate of 30%. Luckily, on Qilindo you’ll find an array of startups that can be a good fit to build and diversify your portfolio.

We live in a time where talented inspiration is bubbling from brilliant entrepreneurs all over the world. Take advantage of the possibility to be part of a business idea that can make a positive impact, in addition to a substantial profit – Just take advantage of the opportunities wisely. 

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