How I take the decision to invest in a startup
An investor receives far more funding requests than the ones he can actually get involved in. Even the proposals that include a good pitch and business plan have to go through a screening procedure in which the potential investor obtains his necessary clarifications. We do have such procedures in our companies and they’re not secret – but, instead, they are highly relevant about any investor’s expectations and steps that entrepreneurs have to follow through. This is the reason I’ve chosen to present our procedure in brief.
1. Opportunity Assessment
The first step involves analyzing the opportunity based on four simple criteria:
- The idea: A unique selling proposition/ the issue it addresses and solves. Is the business scalable or, on the contrary, does it target a finite market
- Experience – the entrepreneur’s / team’s track record.The background and knowledge that they have on the chosen business sector, as seen in the pitch deck, the business plan and the further clarification requests.
- Alignment with our goals. Refers to our previous engagement in the respective business segment and the way the startup aligns with our overall strategy.
- Timeline of the Return of Investment.No, I’m not expecting to get a return the next day. But I’m interested in the timeline being realistic.
Based on the answers to the above questions, every financing request gets a score. If that score is big, then the startup is qualified for the next stage.
2. SWOT Analysis
Every entrepreneur knows what a SWOT analysis means. If I must mention this again, the analysis contains four chapters: Strengths, Weaknesses, Opportunities and Threats. In general, the difference between the first and the latter is that the former refers to the present, while the others refer to the future.
Depending on the SWOT results, the business proposal can be promoted at a later stage.
3. Financial Projections
In this stage, the business is examined with our analysis methods:
- DCF (Discounted Cash Flows): Calculating the cash flow at a later stage in accordance with the current cash flow. Obviously, this method is better suited for businesses with a certain level of maturity, which have started to have their own cash flow.
- Multiples: In the case of a startup that’s just launching, it will be evaluated based on similar businesses that already exist in the market.
- Yield: A cashflow model which the investor can receive, depending on the evolution the business has after a specific period.
- TAM (Total Available Market): The total market that the business products will be able to access.
Besides the yield, during this stage we also refer to the so-called VAR (Value at Risk), an indicator that quantifies the investment’s financial risk level.
4. Due Diligence
This is the last step before the actual decision, where we actually get to the startup’s intimacy, through a series of financial, legal and other forms of audits. The aim of the due diligence implies mostly verifying the perspectives obtained in the first stages and it is the last step before the final investment decision.
Of course, our procedure isn’t the only existing one, and some investors take decisions that are mostly based on the so-called “gut feeling”. However, getting familiar with the terms and methods mentioned above is useful for any entrepreneur that is searching for financing, as it will help him better understand the stages that follow after a startup has been brought to life and to better comprehend the interaction with different types of investors.