Investing in a start-up can be a very lucrative opportunity but a very risky one to be sure. The average person doesn’t have the capital to be considered a qualified investor or the opportunity to invest in start-ups. Yet, increasingly qualified individual investors and family offices are getting in early before venture capital (VC) and other traditional sources of institutional capital. Most people, VCs included, want to invest in an area that they have experience in. Individuals and family offices often get labeled as “emotional” investors. They had a family member with breast cancer or a child with autism and they are biased towards those investment opportunities. But make no mistake, they do not want to throw money away—they want a return on investment just like the VCs.
As someone who has been involved with launching several start-ups as a founder, co-founder, board member and/or investor, there are several attributes that I look for that are good indicators of future success. While nothing can take the place of doing your own due diligence, partnering with others and learning what more seasoned investors look for can help you refine your research. Below are five things to investigate before investing in a startup.
The Founders of the Start-Up
The first thing to look at is the founders of the start-up. Certainly, their educational background is important, particularly for tech start-ups. How is their experience, unique scientific or technical expertise going separate this company from competitors? You should also learn more about the character and commitment of each founder. Are they “all in” and exude a can’t fail attitude? Does listening to them talk about their project excite or inspire you? Have they done it before or is this their first time? There is certainly something to be said for founders with an established track record but remember: every successful founder or entrepreneur had to have their first time as well. Which brings us to who those founders surround themselves with.
Look at the Team
The team is as important as the founder in that it will largely be up to them to execute on the founder’s vision. Early on, you need people who can be jacks-of-all-trades. However, as the company evolves, each member of the team should be skilled and experienced in a specific aspect of operating the start-up, such as product development, testing, marketing, sales, and operations. Again, look for teams that have people who have been there and done that before. Have they worked in a startup before—because it is a very different environment. Have they brought a product from conception thru R&D and commercial launch? Have they raised money? Have they had successful exits in the past? Again, not everyone has to have gray hair and 20 years of experience, but you want some on the team, especially when you hit bumps in the road (which is inevitable).
Evaluate the Vision
Some start-ups may sound exciting, but look beyond the hype and buzzwords. Is there a market for the product and is there a clear path to execution? Remember Theranos? The vision and hype was delivered by a “snake oil salesman” in Elizabeth Holmes. It worked on the Silicon Valley investment echo chamber with big name firms writing big time checks. Yet, they all failed to look under the hood or in this case at the data and the execution plan. There was no substance and no chance they could succeed, but it was too little too late for the investors.
Consider the Competition
Beware of any founder or entrepreneur who tells you that there is no competition for their company. Big red flag! If they tell you this, it means one of two things: they are too lazy to do their competitive landscape analysis or they think you are. Every product, service and company has a competitor out there—usually several. They should be able to give you a full lay of the land and describe each company, product and their business models. What you really want to hear is why this start-up is different. What is their competitive advantage over everyone else? How are they going to rise above the noise and win? What sorts of resources do the competitors have? If a large chain, like Amazon, is offering a product that resembles the start-up’s product, they may be fighting an uphill battle. If the startup has not done their homework on market landscape and their competitive advantage, you need to walk away.
Follow the Money
As we follow the money, the two main questions to ask are: who has put in money to date or plans to and who is going to pay for this product? Who are the current investors? What else do they bring to the table other than capital? Sales leads? Technical expertise? Ask the founders how much of their own capital has been invested in the start-up. Entrepreneurs who are dedicated to their start-up are willing to invest their own capital, and certainly a boat load of sweat equity, before asking investors to help out. Committed founders also understand they may need to draw a smaller income early on as capital is invested into R&D and until the start-up starts generating revenue. This is also why startup life isn’t for everyone! And finally, several studies have shown that the number one reason that startups fail is that there is no market for their product—meaning nobody will pay for it. So, what has the company done to test the market to assure themselves and investors that in a Field of Dreams sort of way,”if they build it they will come?”
These are just a few of the key questions to ask and boxes you want to check off before making an investment in a startup. Be direct if you don’t see the answers you are looking for. Trust me, if their feelings get hurt then they shouldn’t be in the startup business anyway. The entrepreneur who takes the feedback/criticism and comes back having done the work, answered the questions, developed the execution plan and has even more enthusiasm and determination in his or her voice—well that’s the one who just may get you to open that checkbook (not that anyone uses checkbooks anymore)!
Erik Halvorsen is the Chief Business & Strategy Officer at FAR Biotech. As a result of his industry experience, Erik is an often sought-after public speaker, and he has served as an advisor to various hospitals and start-ups. He is constantly looking for new ways to improve patients’ lives while changing the broader healthcare industry for the better. He has been referred to as a “translator,” in that he has the ability to speak science with businesspeople and speak business with science people.