Investing in Startups? What You Need To Know

An incredible $621 billion was injected into startups in 2021, showing Americans’ confidence in funding new businesses with growth potential.

Often, investing in startups has the potential to generate positive returns but has its fair challenges.

First, there’s no guarantee that the business will take off or fail, and there’s always a high chance of the investor walking away with nothing.

Before diving into this investment, you need to know some vital things. Read on for more information.

Know About the Management Structure

A good representation or proposal may look good on paper; however, there could be some finer details that you should know.

It’s essential to conduct quick background checks on the people behind the idea because these are critical to the company’s stability. It has everything to do with working with the right people to get the job done.

Some of the things you need to check include;

• Educational background
• Companies worked
• Their financial stability, including credit reports and scores
• Criminal background
• Identity verification

A solid management team leads investable businesses with ample knowledge and skills. Assess if the team can grow a stable organizational structure as the company scales.

A mix of entrepreneur skills would work to your advantage since you’d be surrounded by people with realistic plans to clear the company’s path to growth.

Know Whether the Company is Scalable

Scalability is the ability of the startup to grow revenues quickly and minimize expenses while building a favorable margin. But, again, you’ll need to look at the business model because some businesses may take time to scale or grow.

For instance, a startup making yogurt will need equipment investment and a ready supply of raw materials such as milk, sugar, and essence.

Scaling up may be easy for such a company. However, it may not be scalable if the company requires much customization, consultancy, and installation.

Before investing, you need to decide whether you want quick short-term, or long-term returns. 

Evaluate the Exit Strategy

Most companies that invest in innovative startups are looking for quick acceleration. A scalable business with good margins must align with its strategies.

As such, every company must have an exit strategy so the investors can know if they can recoup their investment through a sale.

The business proposal must outline the company’s prospects and whether it’s attractive to potential buyers. Then, a possible exit offers you the return you need.

Therefore, you need to look at the amount of money you invest, the stock or asset’s value, the anticipated sale price, and the pre-money valuation.

Knowing how much the business might be sold can help you calculate the probable return on investment.

If there’s a chance that you’ll fetch a significant amount, you can consider increasing the capital. Nonetheless, it’s important to remember that everything is in theory, and the exit predictions will work if the company is scalable.

Look at the Marketing Strategy

The marketing aspect is one of the essential things to consider when deciding whether to fund a startup. A startup must have a clear marketing strategy of how it will market its products and services.

A powerful go-to-market approach can create a greater opportunity to grow the company’s products. Look at the market process, sales cycle, and supply and demand chain.

You can ask about potential customers, products and services offered, and how they compare to the competition. The startup must communicate clearly with its customers and ensure a realistic product roadmap.

Assess the Funding Strategy

There are multiple ways to fund a startup, including working capital, debt financing from financial institutions, CreditNinja.com quick loans, and equity financing through crowdfunding, incubators, and accelerators.

Beyond that, the startup must have its funding strategy and a written plan on how the business plans to obtain funding over a certain period.

As an investor, knowing the funding sources for the startup gives you the confidence that the business will operate without financial hiccups, such as running short of cash to meet general expenses.

It’d be best to ensure that your investment is secure and well-invested for future gains.

Evaluate the Financial Strategy

Even though it may be difficult to calculate the future projection, an experienced team can showcase the company’s roadmap regarding finances.

At this stage, you can review the company’s burn rate, which is the pace at which a startup spends its cash reserves. Notably, if a company spends much money in the initial stages, it may affect its long-term sustainability.

As an investor, you must understand how the business intends to spend money. Look at the expense structure, salaries, and how the founders will pay themselves.

Studies reveal that the salaries of chief executives of a seed-funded startup depend on the amount raised. Still, find out how much other companies are paying their founders.

Overall, there is a strong relationship between the company’s revenue and staff remuneration. Other costs include utilities and rent.

Pay Attention to the Legal Aspects

Every business in the US must operate within the confines of the law. For example, a startup must be registered as an LLC or S-corporation.

Ask for the registration documents such as the operating license, articles of association, bylaws of the company, and Employer Identification Number(EIN) from the IRS.

Evaluate the Contribution Modalities

As noted, the main models of funding startups include series investment, angel investment, seed money, accelerator, incubator, and equity crowdfunding.

It’s essential to understand each model and where your investment falls. The main option for investors willing to fund startups is crowdfunding, whereby you contribute a certain percentage.

Further, pay attention to the ownership structure and your percentage contribution depending on your investment.

Conclusion

 Most startups don’t live to see their first birthday, mainly due to poor research skills, lack of workable strategies, and lack of sufficient funding. Even though investing in startups is full of risks, it can be rewarding when your investment pays off. Even so, it’s essential to do research first before you invest in a startup.