Investing in startups is risky by nature. It’s more art than science, even if you’re following early-stage investing rules with carefully thought out hypotheses and frameworks. The so-called “golden rules of investing” seldom consider the x-factor hidden in the amalgam of the team’s experience, the value-add of an investor or advisor, chance, or the unpredictability of markets. If an investor sticks stringently to fixed rules and fails to factor in a startup’s ability to pivot or the infinite number of incidental factors, then excellent startup investment opportunities can be and are missed.
The Idea — evaluating early-stage investment opportunities, naturally, investors must focus on the viability of the idea. Is the technology or solution going to work once it’s deployed? Is the business scalable? Can the idea be executed and turned into a successful business achieving market-fit?
Product and Business Model — Understanding key aspects of the business model and the product to assess potential risks of failure is nearly as important as the ability to derive your own fair valuation and the price you are paying to invest.
The Founders — The right founders are usually on a campaign to change the world and to improve people’s lives, but will they turn setbacks into springboards. Besides the founders, is the team focused and are the people passionate, complementary to the founding team.
Competition — Can the startup steal a march on their less nimble competitors who may struggle to respond quickly. Competition is a key factor that can demonstrate market opportunity and the viability of the business idea. Is growth possible even in tough conditions to build a successful and resilient business.
Capital Efficiency — The more capital efficient a business is, the less capital it will require to scale. Capital efficient businesses guarantee a higher return on investment for investors. Part of the attractiveness of internet or software-based businesses to investors who want to invest in startups is their low customer acquisition costs and their ability to scale quickly.
Valuation — A startup’s valuation is always subjective. It’s essential that the valuation is equitable for all parties to ensure a healthy future relationship amongst stakeholders. A sign that a fair valuation has been reached is when both the startup and the investors agree on a value that feels slightly uncomfortable.
Diversify — Warren Buffett’s advice that “do not put all eggs in one basket” is one of the evergreens and best investment mantras. Start by making small bets on ideas and faces and adopting a portfolio approach where there are going to be some hits and some flops. The idea is to ensure the hits are large enough to more than makeup for the failures, thereby avoiding big losses. To manage the high risk in each individual company and the potential of a high return, investing in a portfolio of companies balances the odds of success. Of course, there needs to be quality deal flow — startup investing is only as good as the best deals you see.
Amit Khanna is the founder of www.7startup.vc and has 18 years of experience with Startups and the Enterprise with an MBA, focusing on Growth and Investments. Amit supports entrepreneurs with every aspect of their business including concept and product development, investor presentations, fundraising, and scaling up.