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How do investors evaluate startups in reality?

Friday, September 6, 2019

At the very beginning of the way to success, startups get money from the sources also known as FFF(Friends, Family, Fools — auth.). However, such a way is quite doubtful to acquire a sufficient sum of money to develop your project in a normal way. At this point, founders are facing several interesting stages of the project’s lifeline — search and involvement of investors. It is quite difficult, as startuppers do not always clearly understand, what investors need and which project metrics are crucial. Specifically to these criteria, vivid or not really, our today’s article is dedicated.

Startup Jedi

We talk to startups and investors, you get the value.

What is important to the investor?

Businessmen, who invest in the startups, are risking, but at the same time, they have a substantial stimulus — having invested in the successful project, they acquire an income even more substantial than they could have acquired if they had invested in other financial instruments.

To achieve this goal, investors are very scrupulous about choosing a startup. What do they pay attention to in the first place?

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1. Favourable industry and market forecasts

It may sound banal, but at first, a potential investor will not look at the project itself and its perspectives, he will look at the industry in general. Before you start working on the project, you should scrutinize the tendencies in your industry. Possibly, it is better to re-orientate your product to a more successful industry.

For example, among perspective investment spheres in 2019 were highlighted educational technologies (EdTech), artificial intelligence, property sphere (PropertyTech), foodtech market, hyper-personalisation in advertising (ads via Stories, sells via DNA), entertainment and cybersport.

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2. Product, its functionality and competing advantages

The final product of your startup has to solve a real user’s problem. It is important even before the prototype creation, to communicate with the maximum available number of potential consumers of your product; and to understand how they react to the possible variants of solving a particular problem.

An American entrepreneur, the creator of several successful startups — Steeve Blank believes that the main difference between successful and unsuccessful teams is in the consumer orientation. In other words, the study of the client and its triggers is no less important than the development of the product itself.

Scalability is an important startup feature by default. The project has to promise an ability to become a big company, at the same time saving its business model. At this point we are back to the use of your product: if it can solve a problem for many people, it has growth prospects. The greater are the prospects, the more interesting is your project for capital owners.

A startup cannot survive without competitive advantages. If you have a unique value proposition, still not presented on the market — that’s perfect. And if moreover, if a startup already has a client base, it will be a great advantage for the investor.

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3. Startups’ survivability

Some founders believe that their project is impossible to launch without investments. At the same time, the investors are quite cautious about such type of startups: what can you expect from a project, founders of which do not want to invest in it.

Surely, nobody expects that you or your siblings have a few thousand dollars to invest. However, minimum valuable product (MVP), or a prototype, that can be shown to the investor, you can create using own resources. Sometimes it is even enough to work on the bare enthusiasm — your own and your partner’s. As the last bonus, you can give free rein in the project.

A prototype can define reaction of project potential consumers, you can get feedback and taking it into account, you can develop your final product.

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4. Elaborating risks

For the investor, a startup is a bunch of risks, which have to be covered with project value, its development and a number of possible dividends, in case of project success.

The investor will choose the startup, where each of the possible risks is foreseen and elaborated. In your turn, you aim to define all the risks your startup can face and elaborate solutions to those risks.

What risks are common to all startups?

If to look at the risks evaluation methodology, masterminded by Rocket DAO, general risks for different companies of various specifications can be divided on inner and outer. Outer include country, political, economic, operational risks, and risks, relating the danger of the natural disaster. Inner include financial risks, the thread of fraud, risks connected to human resources.

Thus, on the one hand, capital owners will estimate the general situation in the country — is it stable, how does the government behave with the investors and what is going on in the labour market, is it generally safe in the country? On the other hand, they will look at the business processes in the startup and on its team.

If we take a closer look at the risks evaluation, then the following moments can scare off the investor.

First of all, the wrong and/or incorrect definition of the target audience. For instance, your product may not get into the interest area of the target audience. The last-mentioned can be defined incorrectly, it can be way too conservative and not ready for your product to come on the market.

Secondly, low quality of the startup business plan. The project may screw up because of the bad business model, careless planning and, as a result, failure to meet the development deadlines, and careless budgeting.

Case: projects of social networks

About 7–8 years ago, there were many examples of launching projects of social networks/messengers/ dating services for a certain audience, and almost all of them failed. The success story of Mark Zuckerberg, Pavel Durov turned the heads of hundreds of startuppers — and they brought to the market a number of their alternatives.

“Endorphin” “street” dating service was launched in Ukraine in 2011: the user passed the person he liked to a card with a coded link to his profile on the startup website and was waiting for feedback. At first, the project was very successful: it was able to attract investment and take third place in the Rating of Ukrainian startups. However, the service turned out to be technologically complex, and the founders could not scale it. As a result, the project was closed.

At the end of 2014, they launched the Dateprog.com — programmer dating service. It scored more than 9,000 users, but a year later the project was closed. Reason: illiterate business planning. The founders did not foresee the need to develop a mobile application, did not use ready-made chat solutions, instead, they created their own and lost time, they later laid down a viral mechanism to attract new users.

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5. Team

The success of the project directly depends on the team, its cohesion and enthusiasm. Most likely that investors will want to meet with all the startup participants and see how you behave in your team, whether there are conflicts during the work process, and if so, how they are resolved. Both your competencies and determination, faith in the success of the project team as a whole and each member, in particular, are important.

At this stage, a good reputation and authority a bonus for the team can be — both personally yours and members of the startup team. To do this, you need to be well-known: attend profile events and conferences — preferably as a speaker, make useful contacts, talk about yourself and be interested in opinions from the outside. You must be recognizable — in a good way.

The founders are important to adhere to the team spirit. In the first place is your project, and you, your talents and achievements are in the second. After all, it is the startup that ultimately guarantees profit for the investor.

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Why investor can reject to take a project

So your project meets all the key requirements, however, this does not guarantee that the investor will give you money. Why?

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Investors pay attention to who and when was previously interested in your current/previous projects. If someone with a good reputation has already invested in your startup, this is a plus in the eyes of investors: many of them simply do not want to be the first. In addition, capital owners are looking at the size of the share that you have already promised to another investor.

However, if this is your first transaction, you will have to make a lot of efforts in order to finally receive funds for development.

Investment size

Startuppers think that investors have access to unlimited sums and it is nothing for them to invest in their project. It is not true. When choosing a startup, investor estimates, whether he can handle it. Sometimes the requests of the founders are too high, and the investor is simply not ready to invest such an amount in the project. Therefore, it is important for you to pre-evaluate investor opportunities and develop an alternative business plan. It is better to have at least some capital and develop a project than to wait for the weather by the sea, wasting time.

Startup as a hobby

Usually, investors do not appreciate it when a startup is a hobby for a team rather than a permanent job. This is especially true for the founders: if they plan to combine the main work and work on a startup, this is a sign that they do not believe in the success of the project and are not ready to take risks. Founders should be prepared to devote their time to the project — this may be one of the conditions for investing.

Startup as self-presentation

Investors do not like when founders primarily promote themselves and their achievements, a startup, in this case, is one way to demonstrate their success. When communicating with a potential investor, it is important to focus on the project, its strengths, and the elaboration of risks.

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Conclusion

When deciding whether to allocate money for your startup, investors judge from many factors. First of all, they look at a niche, evaluating it for the subject of what this segment of the market will be by the time the product launches. Therefore, the founders, before meeting with the owners of the capital, should analyze the market and, possibly, reorient their startup to a more promising segment.

The project, its usefulness to the client, scalability and competitiveness are the next important factor. If your product does not solve the real problem of the consumer, most likely, the investor will not invest in your startup.

Another factor — the viability of the project — stems from how the founders relate to their startup. Are they ready to devote all their time to him? How much money has already been invested and what has already been done? If nothing is invested and nothing has been done, you will not receive anything from investors.

The next key factor is the sophistication of the risks. Every startup has them and almost everywhere they are the same. The more detailed the team will work out a possible response to each of the threats, the calmer it will be for the capital owners to trust their funds to the project.

Finally, the team and relationships within the project are what the investor will look at when they meet. Do the participants like to work on the project? What do they expect? Are there internal conflicts, and if so, how are they resolved? If the team is able to gain investor confidence, then the chances that it will be invested in a startup will increase.

 

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