12 Apr
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6 min read
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Investment plays an essential role in the growth of startups, but investing in each company would have its risks when a newly-established company starts its operation, its investors have no guarantee that it will not collapse and lose capital. Thus, investors must know the answer to several basic questions before taking action.
Anyone who plans to invest in something makes sure to research it beforehand. The investor must know whether the funds he invests in the business will return and –in the most optimistic case- be multiplied.
The questions an investor needs to ask must be complete and comprehensive enough to leave no doubt since any ambiguity in investment would have consequences. The following are some of the questions that investors need to ask when familiarizing themselves with companies:
Which field does the company operate in?
Which feature makes it distinct from other companies?
How large is its sales market?
How vast is the company’s vision for the expansion of its operations?
Which large problem does the operation of the company respond to/
The questions must be posed from a broader perspective when it comes to investing in startups. Some important and prominent questions are mentioned in the following.
The extent of the investor's participation is determined by the type of investment. In other words, the investors' interaction with the startup depends on the type of investment they make. For instance, a venture capitalist would have limited interactions with the group that runs the startup. On the other hand, the investor views this collaboration from a widely different perspective. He receives a share from the company through his investment which means he would be allowed to make decisions alongside the leader of the startup.
In contrast, the investors who finance a startup alongside other investors will also get a share of the stocks, but would not have as great an impact as angel investors. Thus, the extent of the investor’s participation must be determined when granting capital to startups.
Everyone loves to believe the stories of startups' overnight success, but the road to success and achieving significant returns takes years in reality. Investors must consider the roadmap and timetable of startups and adjust their expectations accordingly. Some may be able to wait for 10 years to get a return while others might like their capital returned within five years.
Investigating the history of startups makes it easier to estimate the horizon of investment. Expenditure estimation –i.e. the amount of money the company spends per month- is among the ways to judge a company’s abilities. Investors must know that great expenditures in startups in newly-established startups might be a signal indicating that they will take longer to return the assets.
Venture capitalists and angel investors often make investments seeking to take entrepreneurs to the peak of success. However, the possibility to make revenue is also an appealing part of the work. In specific startups, investors who are focused on maximizing their income must conduct a Return of Investment (ROI) analysis. However, the return depends on the type of investment as well. An annual return of 30-40% is typical for angel investors. On the other hand, venture capitalists take greater risks which increases their desirable returns. Crowdfunding is as risky and determining its average return is difficult since it is a relatively new phenomenon.
When estimating returns, one must not overlook the investment costs and fees. For instance, annual management expenses might be associated with venture capitalist investments. Crowdfunding platforms charge the investors that use them. The higher the costs of specific investments are, the lower their returns will be.
Diversity is a benchmark for robust investment and the first goal is to minimize the risk without reducing the returns. Investors must be aware of the influence of their investment on their overall asset composition and the amount of risk they are taking when considering an investment in startups; still, finding the right balance is difficult.
In the case of stocks, there are clear divisions between the classes of assets that make risk distribution easier. Startups require a different way of thinking. The general rule is that the more startups the capitalists invest in, the higher their chance of greater returns will be.
All investments need specific strategies, but the importance of such strategies is greater in the case of a startup. Investors must know when and how they can take their initial investment and the respective returns back. For instance, angel investors need to know at which stage they can sell their stocks, which is why they need to know about the time frame to make sure that they can withdraw at any time and stage they are willing to.
“The best entrepreneurs are the ones with a meticulous and clear vision of the future who plan for it? Says Peter Thiel, the founder of PayPal and one of the first investors of Facebook. He stated this after Mark Zuckerberg declined yahoo's $1bilion to buy Facebook. Thiel reasoned that Facebook must take the offer, but Zuckerberg said, "Yahoo has no systematic plan for the future. They did not hold the value they should for what did not exist yet. They underestimated the business."
Many investors – particularly angle investors- actively try to dedicate their time to the startup they invest in and involve in activities ranging from offering consultation to the founder to serving on the board of directors or playing an executive role. They like to keep in touch with the entrepreneurial founders and the work since they understand the significance of strong professional relationships.
People matter more than products in the expansion and development of every business. For instance, emotions flow in a firm with a fast growth where people are committed and work hard, and the attitude regarding how to deal with inevitable barriers might contradict. Under such circumstances, people need to support and work for each other since having excellent bonds plays a significant role in success.
The way the founder communicates with their team members is the main key to the success or failure of every startup. CEOS of newly-established firms have a smaller management team compared to other companies. Besides, their management team might not have a traditional structure where all people are under the leadership of one person. Overall, leaders who manage to establish a close relationship with their management team are more successful.
Investors love the inspiring storytellers that can narrate their vision. Establishing a convincing vision for change is an art and will only be realized when all those working in the business work towards it.
Leaders must portray a clear image of the ideal state if they seek to impact others’ emotions. Founders must be completely determined regarding their goals and have faith that they are different from the others since having broad commitments and vision is contagious and will pass down from the employer o the employees.
In this article, we tried to elaborate on the important questions whose answers you need to know before investing in startups. Posing the right questions, having a clear understanding of them, and answering them make decision-making easier. On the contrary, irrational responses can cost you the possibility of cooperation. Bold investors must thus act wisely when posing and answering questions.
