What do successful private investors look for in a startup?

Most shrewd investors have an extensive checklist before they invest in a startup.

Certain intangible factors come into play, too and the formula for startup investment may not be entirely scientific.

Sometimes an excellent product and an ingenious plan for domination in a lucrative market are not enough. Sophisticated investors are looking at the opportunity from every angle.

Even if every piece of business intelligence they acquire about the startup points to a successful investment, investors may instinctively feel the startup is not for them.

At the same time, they may be so enthused by a startup’s vision to change the world that they choose to overlook certain imperfections in the business plan. Their ultimate decision might hinge simply on whether they like the entrepreneur and are excited by their idea.

There are no guaranteed methods of unlocking startup investment. And, from an investor’s perspective, there will always be some element of risk and uncertainty when backing early-stage businesses.

There are, however, some important characteristics most sophisticated investors generally look for in a startup.

The A Team

The quality of the people driving the startup is absolutely pivotal to securing investment. Basically, does the management team have what it takes to execute the business plan?

A mediocre idea with an A-grade team behind it can succeed as a startup. A winning idea with a second-rate team is on an almost certain path to failure. Angel investors want evidence that the management team has:

• In-depth knowledge of the startup’s market, sector, competitors and target customers
• A track record in delivering success in the relevant sector or in business generally
• Flexibility in terms of being able to adjust areas of the business that aren’t working
• A willingness to learn: are the founders coachable? Will they take advice from external experts on board and delegate duties that others are more capable of handling?
• Personnel plans: a strategy to address any skills gaps in the management team as the startup progresses;
• Passion and determination: as most angels are aware, money alone is not a strong enough motivator for business success. The management team members will need the passionate drive that comes with a greater goal to get them through tough times.

Signs of traction

Malcolm Gladwell’s bestselling book The Tipping Point describes that “magic moment when an idea, trend or social behaviour crosses a threshold, tips and spreads like wildfire”.

He also explains that to bring about one contagious movement – perhaps of customers towards a product – “you often have to create many small movements first”.

Startups searching for their own ‘wildfire’ breakthrough will only find it by consistently working hard at the plan and continually moving forward. Similarly, startup investors often want to see the many ‘small movements’ of team members working towards the goals which will unlock their potential.

When investing in startups, momentum is measured in many ways. Business angels should be able to see the little tasks needed to finesse the company being completed on time. Other markers of momentum, as well as live or preliminary sales figures, include media coverage and the acquisition of new partners, ambassadors, social media followers and newsletter sign-ups. Any evidence of increasing engagement with the product or service among potential customers suggests a startup moving in the right direction.

A powerful market proposition

The market opportunity has to be compelling for investors. They must also believe the startup has the right approach, business model and capabilities to exploit it.

One of the most exciting, but often risky, propositions for private investors is a product or service that shakes up an industry where disruption is long overdue. A shining example of disruption in recent years is Airbnb, which has taken a big bite out of the hospitality market.

Where once budget hotel chains broke new ground, Airbnb’s network of homeowners willing to rent out their property to guests has now created a fresh dynamic in accommodation for global travellers.

Sometimes startup investors want to be part of the hottest high-growth sectors and are simply looking for the best opportunities within them.

As the case of digital music pioneer Napster proved, however, it is not always the first to market that ultimately dominates.

Once the turbulence of disruption subsides, newcomers who have fine-tuned the business model may come to the fore. In digital music, iTunes and Spotify cleaned up only after the lawsuits and resistance from record company bosses had eventually disappeared.

With hot tickets for investors currently including the likes of fintech, the ‘Internet of Things’ and energy storage and green battery solutions, startups entering a crowded marketplace have to prove without doubt that their solution is different to what’s already available to customers. Evidencing the size of the market, the share they aim to achieve and the path to market acceptance are also central to securing investment.

The numbers stack up

Private startup and SME investors have usually built up their wealth in the cut and thrust of business. Fudged figures or exaggerated claims won’t wash with them and most can spot a hole in the financials a mile off.

The entrepreneur with a million-pound idea but no well-researched numbers behind it rarely charms funding out of investors. Any startup serious about winning investment needs a robust financial strategy that is realistic, richly evidenced and factors in every possible overhead.

Headline financial facts include customer acquisition costs, the break-even point, the overall amount of investment needed in the pre-exit lifespan of the business, exactly how the investment will be spent, the calculated value of the business and its route to an exit.

A good fit

When all the pitches, interrogations and deliberations and done, sometimes an investment decision comes down to instincts.

Clicking or clashing with the founders can ultimately dictate whether the angel invests in the startup. Given that they could be liaising with the business for several years before they exit, good rapport between the two parties is clearly important.

Often the investor is attracted to a startup because their career experience fits well with its product or service. Perhaps they feel they can add value and help the startup to disrupt an industry they are already knowledgeable and passionate about.

Ventures with an environmental or social upside, meanwhile, may be working towards a cause close to the investor’s heart. As an impact investor, they have an opportunity to contribute to this cause while also seeking a financial return on their investment.

Investing into startups

There's no definite checklist for investing in startups. Whilst there are always some similarities, every investor will have their own requirements, preferences and ideas.

But the key theme running through them all is confidence. As an investor, you need to be confident you're investing in an opportunity that you believe in. You need to be confident it's right for your portfolio and you need to be confident that should the worse happen, it wouldn't have a hugely detrimental effect on you as an investor.

Everyone can invest in startups today, but we can all learn a lot from understanding exactly what the most successful private investors look for when investing in them.