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The best venture capitalists have one thing in common: they know how to determine if an investment is worth it. You also don’t need to have millions of dollars to be a successful investor – even small investments can pay off if you start early and find the right startup. Over time, you will be able to hone your skills, increase your capital, and diversify your investments.
While early-stage companies can provide excellent investment opportunities, not every opportunity that comes your way is worth the risk. In my years as a venture capitalist and fund manager, I have had the opportunity to look at hundreds of opportunities and narrow them down to a number of promising early stage investments. From creating a solid deal flow to creating a checklist of required documents, here are five tips to help you identify promising startup investments.
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It’s all about the network
If you’re wondering where to start when it comes to finding investment opportunities early on, the answer is: it’s all about networking. The most successful venture capitalists have developed personal and professional networks that allow them to create what is known as “deal flow.” This is the speed at which new investment opportunities are offered to you.
Want to create a strong flow of deals for yourself? Take the time to talk to other investors in person and online and get clear on what opportunities you are looking for. Any early stage deals that you are not interested in should be passed on to others in your network, as this will help solidify your connections and ensure that opportunities are sent to you in return.
Another valuable aspect of networking is the ability to invest much smaller amounts of capital in early-stage startups during “family and friends” funding rounds. This is a great opportunity if you are looking for a low risk investment or are just starting out as an investor as you will be able to enter a new company early on without using large amounts of capital.
Set your hard limits
When you create a strong flow of deals, you will have many early stage investment opportunities. That’s when it becomes important to know exactly what you’re looking for and set hard limits on what you won’t accept. Take the time to sit down and write down a list of hard nos or red flags that you will avoid (such as having to sign a non-disclosure agreement).
These personal limitations will make all the difference when you start looking at hundreds of offers because oftentimes, personality or dazzling presentations can detract from overall launch experience issues. Even if the presentation sounds great, your predetermined guidelines will help you stay objective and analytical in your process. That way, when it comes time to make tough decisions, you don’t act on emotions or personality—instead, you can easily filter out companies that just don’t fit.
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Look at the big picture
If you find an offer that seems tempting with the right amount of due diligence, you’ll want to take a step back and look at the big picture. What is the market for this offering, and are there already other competitors in the same space? Is there a customer base and how big is the growth potential in this space?
Try to fully imagine the life cycle of a product or service from the customer’s point of view and imagine hypothetical scenarios where pain points might arise. You were most likely presented with a very specific, adapted point of view from the start, so work backwards and expand your thinking beyond the box they shared with you. If the offer still makes sense and there are few questions, you have a great investment opportunity.
What are the risks?
With any investment at an early stage, there will undoubtedly be risks. Your job is to determine exactly what the risk is, how long it will last, and how resolvable it is. There are many different types of risk, from technical to command to intellectual property.
Technical risk, for example, refers to the possibility that a product simply can’t be built, so you might need a vetted expert’s opinion if an investment opportunity involves a technology you’re not familiar with. Or there is a group risk that pertains to the nature of the management team, so trust your instincts if you feel any moral or ethical concerns about the personalities of the people you work with. After all, if you choose to invest, you will be with the company for quite some time.
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Imagine the future
As a beginner investor, you must be able to think long term. How will funding change over the next year, five or 10 years? Any strong startup should have a prepared growth strategy that will deal with funding.
You’ll want to know how long the company has before it completely runs out of funding, as well as how much funding it will need before you can eventually exit. And when it comes to exiting a company, you should think about it in the early stages of an investment – after all, it’s an integral part of what makes an opportunity attractive. What might make someone want to buy the company in the end, and what is the plan to achieve that goal?
Takeaway
Investing in a startup is not easy, but with due diligence, early-stage investments can be incredibly profitable. By creating a solid structure that you can follow when considering proposals, you can separate promising opportunities from time wasters. Be sure to stick to your pre-set processes and think long term to build a diversified portfolio – and reap the rewards that follow.