If you’re at all new to startup investing, you might feel a little overwhelmed.
I know I’ve felt that way.
It’s one thing to invest in the stock market. At least there, you’re investing in a public company that has years of financial data and an established presence in the market. Investing in a company that hasn’t yet reached its potential (or even finished building its product!) is completely different.
Startup investing is both an art and a science. Investors can drill into hard data like revenue, customer acquisition costs, market size and more. But they also need to envision what the world will look like years — even decades — into the future… and make a judgment call about whether or not a startup is on track to succeed in that future.
That doesn’t mean investors need to predict the future. But it does mean they shouldn’t look backward.
There are dozens of criteria that investors can consider when evaluating a startup. Is its valuation fair? Is it operating in a large market? Is it led by a competent team? Does it face serious competition? (Our friends at KingsCrowd regularly publish analyst reports that evaluate all of these criteria and more, by the way.)
It’s a lot to consider. And it can be difficult for investors to hear passionate founder pitches and not get swept up in a compelling story.
So to keep it simple, I like to start with three basic qualities. I look for startups with:
- Founders who know their industry.
- A unique value proposition.
- A clear path to grow and scale.
There are many other considerations that stem from these three qualities. But this is a solid starting point. And each quality impacts the others.
It’s not enough for a founder to be charismatic and driven. They must also have a strong understanding of the industry they’re operating in.
Charisma is important for raising money. They need to be able to convince investors that their company is worth the investment. And they need to be able to network and build relationships with not just investors but also potential partners or larger companies that might buy them out down the road.
But charisma isn’t everything. Just look at Facebook founder Mark Zuckerberg. No one has ever described him as charismatic.
That’s why it’s important that a founder also has a solid understanding of their industry (or in Zuckerberg’s case, the industry being built). How businesses succeed in it, how it’s evolved over time, what trends it’s impacted by and more.
If a founder is starting a company in an industry they know nothing about, they need to build a team of people who have that knowledge or bring a fresh perspective that will disrupt the industry. Otherwise, that startup faces a steep learning curve.
A Unique Product
If a startup is trying to address a major problem that other companies have tried and failed to solve, it needs to take a unique approach.
This is where knowledgeable founders excel. They already know what their competitors have done and are doing, and they understand the trends that impact their customers. That knowledge is crucial for creating a truly unique solution.
One of my favorite examples of this is Whooshh Innovations. The company created a patent-protected fish transit system to help upstream migrators like salmon avoid dams and other obstacles. Its system is unlike any other fish passage solution, many of which are inefficient and hurt the fish they’re designed to transport. And Whooshh Innovations has more than 40 patents to its name, which help protect and maintain the company’s unique value proposition.
Copycat companies can still carve out a place for themselves in a given market. But the truly innovative companies that pioneer new technology and throw the traditional playbook out the window? Those are the companies that change the world… and give investors massive returns.
A Clear Path to Growth
A startup’s path to growth is a tricky blend of data and predictions. If a startup has a finished product and is already generating revenue, projecting its future revenue is easier than if it were still in the development stage.
But it’s still not guaranteed. So it’s important for founders to show a clear path to growth — regardless of whether they have a finished product or not.
A founder’s industry knowledge and unique approach both inform their startup’s growth. So if you’ve found a startup that checks the previous two boxes, you’re on the right track. But there’s still more you need to know to assess the company’s potential.
A few questions to ask a founder to see if they have a clear path to growth:
- How do you plan to expand your product/service offerings?
- What’s your plan to acquire customers?
- How do you define your success in terms of market share? What are your market share goals for each of the next two years?
- Do you plan to expand your team? Which positions and areas of expertise will they cover?
- Do you have any partnerships in place? Do you plan to?
- Where do you see the company in three years?
- Do you have an exit plan?
If a founder can give you straight answers to all of those questions, it doesn’t mean the startup is guaranteed to succeed. But it will give you more information to better evaluate the investment opportunity.
In general, investors should keep in mind that startup deal flow is better than ever. There’s been an explosion in the number of unicorns in 2021 alone. And that high quality is spread among a growing number of startups.
That gives investors like you more opportunities to find high-quality investments… and a better chance at big returns.