The now popular word “startup” means a business project that was recently created or is still underway in development. In order to continue to grow, such companies look for investors who invest in start-up businesses to receive a large percentage of the profits after a while. 

In this article, you will learn how to invest in a startup.

WHAT IS INVESTING IN STARTUPS?

The other side of the moon is that they are looking for the most promising projects to invest in. No one will give money to a startup that is uninteresting in terms of profit. Finding the right one is very difficult: many promise profitability but even in the IT field, only one out of 100 startups becomes successful. The opportunity to get a return increases if you carefully plan and select objects and conduct a qualitative analysis of all parameters. In addition, a smart sponsor will not confine himself to investing in one project but will distribute investments among several startups, because diversification is necessary here too. Experienced investors act as follows:

• They choose areas in which they initially sort out well. It allows reducing time and money to study the chosen niche. 
• The partners are selected who thoroughly know the chosen area and who can be trusted.
• The search for startups begins with a subscription to specialized resources/publications, and participation in industry events, most of which are usually international.
• They understand that cutting-edge ideas are difficult to squeeze into the framework of logical calculations. They rely not only on intuition but also on the potential of the startup team.
• They agree on negotiations with the founders and evaluate the impressions of the meeting.
• They ask for a business plan to make sure that the marketing and future vision of the startup’s leaders are adequate.
• They try a product or service to see the prospects for themselves.

HOW PROFITABLE IS IT TO INVEST IN STARTUPS?

According to a study by CrunchBase, on average, startups attract from $25.3 million of investment money and are later sold for $196.8 million. The profit of investors is about 676%. If we remove the owners who invested in their own business from this figure, in this case, a half or a quarter of the sum will amount to 350 or 175% of the profit. And even such profit looks very attractive. In the same study, it was recorded that after 18 months of a startup, investors can successfully exit the project. It is also beneficial to exit after 7 years but too long a waiting period is not inspiring. 

REASONS TO INVEST IN STARTUPS

How to invest in a startup? Attracting investments is driven by the desire to implement an exclusive project or idea when there are no own funds. The investor’s interest lies in the fact that the sooner he invests money, the faster the capital will multiply. When a preliminary analysis has been carried out and satisfactory results have been obtained, the investor proceeds to discuss certain terms and the extent of his involvement. Just relaxing and waiting for a return on investments is not an option. It is necessary to maintain at least a minimal connection with the business where the money is invested. 

Remember that you are investing for a long time (from 2 to 5 years or for a period of 6 to 24 months). Therefore, be patient and help in any way you can: share your connections, form the company’s reputation in the market, and so on. It will increase profits faster. You can participate in management through the board of directors, recommend the company to your influential friends, and organize the writing of product reviews on the company’s website. You act as an assistant. What about current issues, business solves them on its own. It’s a fact that the situation usually looks different inside and outside of a startup. It is important to follow the hierarchy and not take on more than what is permissible. 

HOW TO RECOGNIZE A PROMISING STARTUP?

Even beginners can start investing. The list of requirements for a company includes three parameters:

• Who is on the team? Who leads it?
• What are market features?
• Is there a product/service analysis?

Scoring method

Its author is Bill Payne who proposed to analyze several startups from the same field according to the following criteria:

• composition of the management team (the share in the total assessment is up to 30%)
• market niche size (up to 25%)
• product/service/technology (up to 15%)
• analysis of the competitive environment (up to 10%)
• marketing and sales analysis (up to 10%)
• the need for additional investments (up to 5%)
• other factors (up to 5%). 

Based on these figures, the investment attractiveness of the company is considered. 

Venture capital method

A startup is evaluated before investing and after the money is invested.  Post-investment value (in a year or 5 years) is calculated based on the current sales growth rates of other startups in the same niche. The received amount is divided by the expected return on invested capital (ROI). Regarding the pre-investment value: the amount of investment is subtracted from the post-investment value.  

Berkus method

This is when a company is compared with similar businesses based on 5 main indicators:

• product/service idea;
• prototype analysis;
• quality of the management team;
• development strategy; 
• sales analysis.

HOW TO EVALUATE A PROJECT AT THE LAUNCH STAGE?

This is the most difficult since the risks of losing investments are too high. But fortunately, investing just in an idea is usually small. If the yield is weak, the loss will not be painful. In the case of high profitability of a startup, the investment will fully justify itself. Therefore, relying on purely economic calculations is not always right: it is necessary to consider not only profitability and KPI but also intangible things.

HOW TO EVALUATE A MATURE BUSINESS?

It’s a startup, which works and has a profit. So, we evaluate it like any working business but with a remark that it’s is just the beginning. Phil Nadel, the co-founder of Forefront Venture Partners, recommends focusing on the following metrics:

• performance indicators (KPIs);
• cost of acquiring a new customer;
• LTV (how much profit one client has brought to you over the entire life of the project);
• number of unique users per month; 
• rate of return;
• conversion rate.

Successful startup owners are usually persistent in achieving KPIs. If the owners don’t know the KPI, then this is a wake-up call. Even if the indicators are formal, they still characterize the viability of the business. To make the assessment more objective, you can contact specialists who will thoroughly delve into the startup and determine its approximate cost. A trading school will also help with this. The investor will receive all the comprehensive information and then make a decision. 

HOW TO INVEST IN STARTUPS?

Investing in Internet startups is gaining popularity. And not to the company as a whole, but only to its website. You need to delve into the ways of monetizing the web resource to discuss the conditions for investing in the startup and make sure that the idea is profitable. Moreover, investors usually take an active part in the development: they interact with the manager and experts, help to draw up a business plan and engage in strategic planning. The success of a startup depends directly on the degree of trust, the objectivity of the information provided, and the rationality of investments. 

HOW TO PROTECT STARTUP INVESTMENTS?

The overall picture is not as rosy as it seems. The risk statistics say:

• 8 of 10 startups are unprofitable.
• Solutions are developed by people who have no experience in such matters, which leads to large losses.
• 33% of new companies are created by scammers for the sake of enrichment.
• 6 of 10 businesses close due to internal contradictions.

A responsible investor will weigh all risks before making a decision. Unfortunately, most startups are like a pig in a poke. There are a lot of scammers in this niche and there is no legal framework. Therefore, you should attract lawyers who would help you competently draw up an investment agreement. The agreement must include the purpose, the basic conditions for cooperation, the rights and obligations of the parties, the form and frequency of reporting, tasks and deadlines. To diversify risks, money should be invested in several businesses. Be ready that ⅔ of investments are likely to be lost. 

EXAMPLES OF SUCCESSFUL INVESTING IN STARTUPS

Many are interested in the percentage of successful startups. The most successful in the IT field is Reid Hoffman who founded the first dating site SocialNet in 1997. Then in 2002, he founded the social network LinkedIn for communication between professionals from different fields of activity. In total, he has invested in 80 startups for all the time including even Facebook.

Facebook was a successful and promising startup 6 years ago: it attracted the attention of the leadership of the legendary company Accel Partners. This organization invested $13 million in Facebook when it had about 1 million users. Today, Accel Partners owns 10% of the shares worth $5 billion.

Marc Andreessen created the first Internet browsers Netscape and Mosaic back in the 90s. But most of his fortune came from investments in LinkedIn and Twitter. 

HOW TO BECOME AN INVESTOR?

The usual minimum investment in startups is equal to the price of one share. It is about $10, so theoretically anyone can become an investor. But in practice, you need to invest in those industries in which you are well versed. Shares of small companies can rise or fall in price even in the absence of significant news. At the same time, the business is developing normally, so it makes sense to make long-term investments: several months will not help you figure out how successful the company is or not. Particularities of investments in startups in Ukraine:

• Startups often appear in projects from inefficient industries in which technologies have not changed for a long time. 
• Investors look for them mainly by recommendations from friends or on Facebook.
• The range of various investments ranges from $30,000 to $300,000. This is average data.

There are also large participants in this market who invest tens of millions of dollars in startups. The figures above allow us to objectively judge the state of investment in Ukraine. Concerning the investors from the West: they follow the 30/40/30 formula. On average, 30% of investments will be unprofitable. The projects with the other 40% invested will be weak. Only 30% will have more or less decent results, but not a fountain. Only 3-4 projects of 20-25 turn out to be successful.

CONCLUSIONS

• For beginners, the way to join investment funds or pools of several investors is ideal. Such investors can make a profit and minimize losses easier.
• To increase the share of future profits, you can start training startups on your terms. People who head young companies often have poor knowledge and skills for business development. They don’t know fundamental analysis, so your recommendations as an experienced businessman will be valuable to them.
• Look for projects at domestic and foreign exhibitions, competitions, and conferences dedicated to startups. Also, the information about events can be in specialized media and thematic sites.

A startup has a chance to become a super-profitable company with the help of investors’ money. In this environment, there is a minimum of formalities, so it takes little time to make decisions and implement ideas quickly and creatively.

On the one hand, investing in a startup seems like a lottery. But on the other hand, investing is also a profession that can be learned. For historical reasons, it is worth learning from Western investors, since the private property has never been taken away by law there. Ukraine is a promising country, so there are big opportunities to increase your assets.

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