5 questions

5 critical questions to ask yourself before investing in a startup

Making your first investment is an important move and we can only congratulate you about such involvement in the ecosystem. Investing in the real economy can help you have a direct impact on job creation and in fostering innovation. It can also be financially rewarding. For all these reasons, startup investing is now the new hype, but before becoming a real angel, you should seriously consider answering to these 5 questions.

1. First of all, should I really invest in a startup?

Basic question, but so many people disregard it. Don’t get me wrong here, we do not want to discourage you, but rather prepare you to make your first investment having in mind all the risks associated. Startups are not a safe investment and you can potentially lose all the capital invested. Because startups are risky, it is often suggested to not allocate more than 15% of your portfolio on this investment class. Startups are also illiquid and should be considered as a long term investment. In short, invest only the money you will not need from now to 5 to 7 years. Spread this 15% over several startups, not only one. The more you diversify, the better your chances are to make a return on investment.

2. Where do I find great startups?

Now you know investing in one startup only is not conceivable. To diversify properly your portfolio, you need to find not only great startups but also great startups that are looking for funding! Of course you can screen the market yourself, make your own due diligence and make your proposal to the few elected candidates. But if you have a day job, a family, some hobbies you may not be able to stretch you time and manage to review hundreds of startups a year. Delegate it to professionals who are doing it full time. Equity crowdfunding platforms are reviewing hundreds of startups a year, you just have to be registered and wait until they propose an investment that suits your needs. The beauty of it, is that in most of the cases it is totally free and of course with no obligations.

3. Am I paying the right price?

This is another important question. What is the pre-money valuation? How much equity will I get? From the DCF to the comparable method, there are many approaches to valuate a startup, and of course the price you pay is directly derived from the methodology the startup adopted. If you are a finance professional, you will have no issue with that. But if you are not, this can be a tricky as for every good or service you purchase, you do not want to pay more than necessary. The best is to find a third party who can challenge the valuation and negotiate terms with the entrepreneurs. Most equity crowdfunding or online investing platforms are offering this service for free so why not taking advantage of it?

4. What will the startup do with my money?

A clear spending plan is a must, no one wants to pour money in a black box. A break down of the capital (to be raised) by category will help you determine if the entrepreneur will wisely allocate the resources. What you should also pay attention to is if this spending /investment plan is consistent with the growth expectations of the startup. Quite obvious but what if the startup doesn’t raise the full amount sought. You should receive different scenarios and plans from pessimist to optimal.

5. How will I make money?

Probably the most important question. Ok to invest today but how and when will I get my money back (ideally with some profits). Of course no entrepreneur has a crystal ball, and no one can commit to tell you exactly how much money you will make in 4 to 7 years from now. But at least, the founding team can present some potential exits. First it will tell you lot about the entrepreneur’s mindset. Does he want to build a life style business or does he really want to lead his venture to the highest level reachable. Second it shows that the entrepreneur has made his homework and knows his market. Who are the main competitors, will the market get consolidated in the coming years, similar startups recently acquired, who can be the potential buyers. Nothing is written in the rock, but at least you will have some indications.

Startup investing is really exciting and doesn’t have to be complicated. I hope these 5 questions will help you make a decision about any potential investment in a startup. You have a different approach, routine before investing in a startup, please share with us.

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