A startup can be a good company and still be a bad investment.
I’ve seen angel investors evaluate startups based on the founder, problem, technology or product, early traction and market size—and even review the financials, cap table and legal documents.
But what about the industry around the startup?
A large market does not generously distribute its billions among every company that enters it.
Before investing, there are a few other questions worth asking.
Where will the money actually be made in this industry?
The industry may grow rapidly while most of the money goes to manufacturers, infrastructure owners, suppliers, distributors or platforms but not by the company being evaluated.
Will the startup retain its margins?
Or will suppliers gain pricing power, distributors control customer access, and larger companies eventually bundle the offering into something they already sell?
Is this a venture-scale company or simply a good SME?
A business can be profitable, respected and commercially viable without ever producing the scale or exit required for venture returns.
Will the surrounding infrastructure and regulation mature within the investor’s return timeline?
The startup may depend on new infrastructure, regulatory changes, customer awareness or an ecosystem that does not yet exist.
You can be completely right about where the market is going and still be ten years too early. Investors do not receive returns for being philosophically correct.
Can a larger company commoditise the startup’s product ?
The biggest competitive threat may not be another startup doing exactly the same thing.
It may be a larger company in a neighbouring market that can add the same capability, bundle it with an existing offering and distribute it at a lower cost through established networks.
Has the expected growth already been priced into the valuation?
A great company bought at an unreasonable valuation can still be a poor investment.
The company may grow exactly as expected while the investor makes very little, because the upside was paid for at entry.
Who will fund the startup after this round?
Some companies require several rounds of capital before reaching meaningful/commercial scale.
Startup evaluations must include the sector understanding, industry’s value chain, market maturity, competitive structure, regulatory direction, capital requirements, global benchmarks and possible exit routes.
Before asking, “Is this a good startup?”, ask:
What needs to be true about this industry for this startup to become a good investment?
Angel investors, family offices, emerging funds and corporate investors entering into sectors without internal research teams, hit me up.
I do market advisory for investors and startups in climate-tech and sus-tech.
Credits
This post is written by Deepa Sai for EcoHQ