When looking to invest in a startup, there are several factors that need to be considered. Of course, a good return on investment is at the top of the list, but there are other variables that need to align for an investor to see a viable opportunity.
When we consider that 90% of startups fail, angel investors need to carefully evaluate potential investments. At Pitchdrive, we qualify and validate startups for investors. We manage their personal startup inflow and handle the valuation, legal and operational work.
Based on this experience, we’ve compiled a list of considerations for angel investors before they deploy capital:
A solid business plan
One of the first factors an investor should look for is a solid business plan. According to Harvard Business Review, entrepreneurs looking for investment are 19% more likely to make a plan on paper than those not seeking finance.
Investors need to see a complete plan that includes financial projections, marketing strategies and research into the marketplace. The plan needs to be forward-thinking and demonstrate the startup’s vision. It should include details of how the business will scale and stay competitive in the industry.
An attractive startup will directly address how an investor will make money from the investment, and investors should be looking for transparency and honesty. Any indication that finances or capabilities have been exaggerated should be an immediate red flag. Investors should also be looking for an investment structure that allows them to be involved and use their expertise to help grow the company.
A credible founding team
Experienced investors know that investing in a startup means investing in people. The founding team behind the business is just as important as the idea itself. An investor should look for a team that has both the skills and the personal qualities required to grow a startup into a successful company.
Despite the idea that most successful startup founders are young, according to Harvard Business Review, the average age of a successful startup founder is 45. Experience, therefore counts for a lot in the startup world, as does determination, resourcefulness and a positive attitude, which can go a long way to overcoming inevitable challenges.
The makeup of every startup will be different, however an investor should have a preferred management structure in mind when choosing a business to invest in. For example, to some investors, a credible founding team might have someone who is skilled at marketing, someone who has a head for numbers and someone with technical expertise.
A founding team also needs to demonstrate leadership. Investors need to know that the team has the right temperament to make effective decisions that will drive the business forward.
Some questions investors should ask when evaluating a management team include:
- How long as the team worked together?
- What is their motivation behind the business?
- What experience and skills does everyone bring to the table?
- What makes them the best people to bring the startup to market?
- How can the team be scaled over the next 12 months?
Investors need to know that their investment has the potential to make them money. Therefore, a startup needs to demonstrate a high enough return for an investor to consider its worth.
One way of qualifying a startup’s growth potential is to look at what it has already achieved in the marketplace. Has it gained early traction with a growing and loyal group of customers? If so, then the evidence points to the potential for even more growth with financial backing. If an idea already works on a small scale, it becomes easier for an investor to envision it working in the wider marketplace.
When evaluating forecasts, investors need to be conservative in their thinking and question whether the startup’s claims are realistic. It’s important to consider how much of the market share a startup can conceivably occupy with the right marketing and infrastructure.
Every angel investor is looking for a higher return than they would typically see on the stock market, which is around 9.2%. Every angel investor has a different risk tolerance and there is no one single metric that determines how much of a return an investor should seek.
It’s important for angel investors to remember that it can be easy to get caught up in the frenzy of an exciting business idea. However, if the startup doesn’t have potential to grow, it won’t be worth pursuing.
A large enough market
Investors need to carry out due diligence on the market itself. Investors should know what the market’s net worth is, what companies already operate in the space and where the gaps in the market are. A startup with a solid understanding of the market should be able to project what percentage they’ll be able to capture over time.
If the market is too small, an investor won’t make a high enough return to justify their investment. If the market is large, an investor should be asking how the startup plans to corner a particular segment or niche within it before expanding into other areas. It’s also important to check how saturated the market is and whether it’s possible for a new company to stand out.
Essentially, a market needs to have a significant reach to enable enough growth to yield a good return. Of course, not every product or service will have a global market, but it needs to be big enough so that the economies of scale can be applied to increase margins and profits.
A viable exit strategy
According to the Exit Planning Institute, 66% of business owners are not familiar with all of their exit options. As an investor, it’s therefore essential to have a strategy in mind before deploying capital as the startup may not have considered this in their plans.
The three most common exit strategies are:
- Initial Public Offerings (IPOs) – where the startup provides investors with an opportunity to obtain capital by offering shares through the market.
- Strategic acquisitions – where the startup is acquired by another company, for an agreed price.
- Management buyouts - where the startup’s management team buys the assets and the operations of the business.
For example, an angel investor might take a 20% stake in a startup in exchange for $100,000. Looking at the startup’s financial projections, they might decide that once company has $400,000 in the bank, it will buy the shares back using $200,000 of those funds, doubling the original investment.
Every angel investor will have a different strategy in mind when investing, but the core idea is that they want to be able to ‘cash-out’ with their original investment, plus some extra.
At Pitchdrive, we help investors grow their portfolio. Based on our years of research and expertise, we’ve hacked the qualification process. We can manage your personal startup inflow and take over the qualification, valuation, legal and operational work for you. From sourcing and qualifying, to tracking portfolios, everything is managed from a single app.
Learn more about how we can help grow your portfolio.