As an entrepreneur who's looking to attract funding, it's imperative that you understand what investors are looking for in startups. By getting a clear idea of what investors want to see, you can better frame your pitches, and guide your conversations to encourage positive outcomes.
The Importance of a Formula
Ask any investor what they look for in startups with high growth potential, and they'll begin to rattle off a list of trademarks that they search for and red flags that they avoid. While they may not refer to their process as a formula, that's essentially what it is. If you want to be a successful startup investor, you must follow a formula. That's the only way to keep your emotions in check, and make sound decisions that are likely to deliver high returns.
There's no such thing as a perfect formula--and most undergo frequent changes and tweaks--but having a process will help you to identify profitable opportunities that others might miss.
Investing in an unproven business is a lot like betting on a sports team to win. You can study the trends, and look at historical data points, but you're always taking some kind of a risk. If you want to learn about investing analytics, study sports handicappers.
"For me the most important tip I can give someone trying to beat the NFL is that you need to become a good oddsmaker," says Allen Eastman, an experienced NFL handicapper. "Each week I use all of the statistics and information that I have available to set my own spreads and totals for all of the games."
As an investor, the takeaway is simple: don't listen to what everyone else tells you. Do your own research, develop your own formula, and put your money where you believe it'll deliver the highest return. Your investing formula is the only thing that matters.
Five Keys That Investors Look For
With that said, you need to identify important keys, and give appropriate weight to the different factors that you deem valuable. In no particular order, here are a handful of the things that most investors look for in promising startups. Which do you find most valuable, and which do you believe are irrelevant?
There are certain elements of a startup that can be fixed and others that are unchangeable. The makeup of the founding team falls under the latter category. You can't force change upon a startup's founder. They either have what it takes to be successful, or they don't. An entrepreneur may have all of the knowledge necessary to launch a venture, but do they have the passion to navigate through difficult seasons? A founding team may be capable of creating colorful presentations and well-worded briefs, but do they really understand what's happening at a foundational level?
As an investor, one of the first things you need to consider is the founding team. Look at their history, ability to lead, incentive to succeed, and overall versatility. If you don't feel good about the founding team, you can't be confident in the future of the business.
The next thing that investors turn their attention to is the pain point. Any time you're studying a new startup, ask yourself three questions in regards to the value offering:
If you can answer "yes" to the first two questions and "no" to the last one, then there's a clear, unsolved pain point. This is promising, but it doesn't mean that you've found a startup worthy of an investment. You'll now need to turn your attention to the actual product.
Investors want to be sure that a startup will be successful before investing money in the venture. One of the best ways to do this is by studying past performance. While past performance isn't always indicative of future success, it's generally a good indicator.
You can look at any number of metrics to determine success, but analyzing sales momentum in the form of data is the most objective method of studying success. If the startup has been in business for any amount of time, they should be able to supply you with this data.
A startup can have the right people, a palpable pain point, and some sales momentum, but you're investing in its future growth. What happened in the past does very little to deliver a return on your end. That's why you need to study the startup's business model, and consider its feasibility.
Does the business have the right structure? Is the business plan accounting for future competition? What are the three, five, and ten-year goals? If you want to feel confident in the long term growth of the business, you need answers to questions like these.
As angel investor Basil Peter points out, "Over-valuation is one of the most common structural problems angel investors encounter." If you over-value a startup when you present an investment, you'll find yourself swimming upstream for years to come. The negative repercussions of over-valuing are hard to overcome.
While a founding team obviously wants to attract as much capital as possible without giving up more equity than they feel comfortable forking over, the reality is that the investor often does the entrepreneur a favor by correcting the valuation. They may not like the fact that they're getting less capital on the front end, but it'll save a lot of headaches down the road. With that being said, make sure that you only invest when the valuation is fair for all parties.
What Does Your Formula Look Like?
If you're going to be a successful investor, you'll need a formula. While successful investors typically rely on the five factors mentioned in this article, your list may look a little different. Remember, as Eastman suggests, in order to be successful, you need to become a good oddsmaker. What does your formula look like?