Startup investments are very risky ventures, but if you find one with the potential to provide returns, it can be a lucrative opportunity. The hard part is finding out which startups have the potential to grow and generate profits and which ones you should avoid.
While there is no way to guarantee a return on your startup investment, you can identify certain traits which can indicate a positive growth trajectory. As with all types of investments, conducting research on the startup can help inform your decision.
How to Research A Startup Investment
There are eight different areas of a startup investment that potential investors should research before funding a company:
1. Burn rate and runway
Knowing how much cash the startup is using and how long the business can last before running out of cash is essential to making a wise investment. Burn rate is the rate at which a company burns through its available cash.
Runway tells you how much time the company has before it burns through all of its available cash. It’s important to note that burn rates can be in a constant state of change due to fluctuating costs such as hiring, marketing, rent, and much more.
2. Capitalization table
Often referred to as a Cap Table, this is a spreadsheet that displays the ownership of a startup. Shareholders, venture capitalists, and all other forms of investors will be listed on this table.
According to Harry Alford—co-founder of Humble Ventures—there are five things that should be included on the cap table:
- Pre-money valuation
- Post-money valuation
- Post-money shares
- Investor percent ownership
Some cap tables also include information on sales, transfers, cancellations, and other financial transactions that have occurred. A detailed cap table can sometimes indicate that the startup is organized and transparent about their financial records.
3. Composition of the team
There are a few different ways to verify the background credentials of a startup team. Start by looking at their LinkedIn profiles. If the leadership team doesn’t have a presence on LinkedIn showing their past experience, see if they have other social profiles that can provide some insight. If you still can’t find useful background information, consider that a red flag.
Next, research the educational background of younger team members to see what credentials qualify them for their current positions.
Finally, search for the leadership members by name in Google. If they’ve held prior leadership positions you may be able to find press releases, blog posts, news articles, or interviews they participated in.
4. Social proof
Social proof occurs when “people assume the actions and behavior of other people in order to reflect the ‘correct’ behavior.” Some of the most common forms of social proof include:
- Reviews, testimonials, and case studies
- Partnerships with credible brands (usually by displaying logos)
- Sales numbers and engagement metrics
These elements can add authority a startup’s reputation because it often demonstrates customer satisfaction, product or service efficacy, and sales success.
5. Initial start date
A startup’s age can sometimes serve as a warning when researched in context. Startups that have only been in existence for a couple of years or less may not be ready to receive investments and often haven’t figured out how to scale yet. The last thing you want is to invest in a company that doesn’t actually need funds.
Companies that have been in startup mode for more than five years without showing significant growth may not understand how to properly allocate funds.
On the other hand, many startups are run by successful, experienced teams that are prepared to accept funding and use it to support growth.
The bottom line is this; take the age of the startup with a grain of salt. Even good startups run into problems every now and then, but they should still display a steady growth trend.
6. Current investors and advisors
Mentors, advisors, and angel investors can be a huge benefit to startups. Look for people that act as advisors to the startup you’re researching and determine whether they’re an asset or liability.
For example, if you were researching an early-stage company and discovered that Mark Cuban was an investor, your interest would probably increase. The fact that an entrepreneur as successful as Mark Cuban was willing to fund this startup could indicate that he believes it’s a good investment.
7. When returns are expected
It’s impossible to predict whether or not a startup will provide a return on investment. Investing in startups is a long-term process. The more funding rounds a company initiates the longer it can take to generate returns.
In contrast to that, some companies may target a liquidity event—such as an IPO—which means investors will receive a return on their investment.
The only thing you can really do is review financial projections, cash flows, and exit plans, and make your own prediction for when you might expect a return.
8. Legal situation
Lawsuits on intellectual property (IP) can be a sign that the startup didn’t invest time and resources into protecting its IP. Make sure the startup has a registered trademark, patents, and protections on other IPs.
Choosing Startup Investments with Economic Opportunity
Aside from researching a company’s founder and team, social proof, burn rate, investors, and capitalization table, you also need to review its economic opportunities.
The greatest startup idea in the world won’t be able to move past square one if the market opportunity doesn’t exist or there isn’t sufficient demand to support revenue growth. Sure, the burn rate and runway can indicate potential revenue to some degree, but you also want to know the following:
- What is the market size?
- What is the industry’s projected growth?
- What market share do competitors control?
- Is there potential for additional revenue streams?
- Is there a product-market fit?
Some startups will answer these questions in their pitch decks. Make sure you identify the answers to each question and thoroughly investigate their financial records and projections.
Focus on careful, thorough research to give yourself the best chance at defining a good startup investment.
Each of these factors are carefully considered during MicroVentures’ process in determining which companies will be listed on our platform.