Investing in early-stage companies presents a world of exciting potential, including the opportunity to get in on a new product or service offering at the ground level. While investors risk losing their entire investment, there is also the potential for unprecedented return. Typically companies have their lowest valuations and share prices in their early stages, so investing early can equate to tremendous gains in the future.
Since this type of investment is also high-risk, it’s important to do a thorough evaluation of any company you’re considering investing in. Extensive review and due diligence are important, and every investor has their own set of criteria they look at. While there are many metrics an investor should evaluate in a startup, we’ve rounded up five key criteria to get you started on your due diligence process.
- Gross Margin - There are many profitability metrics to consider in evaluating a small business, and different metrics will be more or less pertinent depending on each company’s specific industry and business model. However, one go-to criteria to consider is gross margin, which is the difference between revenue and cost of goods sold (COGS). Knowing these figures will give you insight into the company’s profitability, and will be a key indicator of how much money the company has to grow their business in other key areas such as sales, marketing, research and development, talent acquisition, and so on. With many startups, however, these metrics are often projections. Rather than evaluating their current margin, investors often need to evaluate their potential future margin.
- Recurring Revenue - Another critical profitability metric is that of recurring revenue, which will serve as an indicator of the company’s growth potential. Find out what strategy the company has in place to ensure a steady flow of recurring revenue, which will serve as an indicator of the company’s runway and opportunity to grow.
- Brand Position - Evaluate the company’s value proposition, vision, mission and key messaging. Learn about why the company does what it does, what their north star or guiding light is, and what will differentiate them in a saturated market. Most startups don’t have big marketing budgets. That means they’ll need to rely on a strong brand position that’s buzz worthy, and will generate organic word-of-mouth marketing and be newsworthy, so as to attract unpaid media placements. Look for signs that the company has natural brand champions and advocates.
- Leadership Team - One of the most defining characteristics of a company’s future success lies in the hands of the leadership team. When possible, be sure to meet those in charge individually, and also assess their team dynamic. Do they seem to have a healthy and supportive work culture and team spirit? Do they possess grit and a can-do attitude? What’s your gut feeling when you meet them? For every company listed on FrontFundr’s Pitch Place, we hold investor events to facilitate the process and make it easy and fun for potential investors to get to know the companies they’re considering investing in. If you aren’t able to attend an event because you live too far away, or because of scheduling conflicts, you can still get to know the leadership team via videos, websites, LinkedIn profiles, and even a Google search.
- Exit Potential - Ensure that the company you’re evaluating has clearly identified an exit plan. If the company anticipates a future acquisition, make sure they have a fleshed out strategy for their acquisition—from who a potential acquirer would be to what their timelines look like.
If you’re new to investing, it’s important to develop your own due diligence process and a set of evaluation criteria. We recommend speaking with a trusted advisor, engaging in extensive research, and also listening to your gut.
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This article has been prepared by FrontFundr, a registered trade name of Silver Maple Ventures Inc. (SMV), an Exempt Market Dealer, and is for general information only. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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