More and more people are leaving their 9-5 jobs to embark on the exciting, challenging and initially tough job of building your own startup. As the light bulb moment has happened and you’ve got the idea that you passionately want to pursue, setting it up, allocating initial capital and getting on with it, comes naturally to you. Every startup goes through this journey and step by step achieves the milestones they set out to do until you come to a stage when you need to scale the business to a new height.
This could happen in many ways. It could be that you need to expand your operations, invest in research & development, increase your market reach or even try to supply for the increasing demand. For whatever these reasons might be, a startup will eventually come to a stage of needing to expand that will inevitably require a large capital.
There are many ways a startup can raise capital. One of the most common and widely known ways is in getting an investor on board. Although, many may have heard about doing this, getting an investor to get to know your startup and invest in it, may not be as simple as it sounds.
In this article, we explore the key investor expectations when looking at investing in a startup.
Most startups believe that investors look at the startup idea, how innovative and unique it is during decision making. Whilst this is true, there are other key areas investors pay a lot of attention to.
‘Investors invest in people, not companies’, is a common saying you hear in the world of startups. This is true to the extent that, companies are run by people. Therefore, the success or failure of the company depends on the people who run it. What is important to remember by startup founders is that, while investors have the funds to invest, it is important to them that they put their money into companies where there are strong founders who are experts in their area and can also be trusted to handle the investment in an honest and meaningful manner.
Investors also look at the immediate team who are involved with the startup and their profiles. Some of the key questions investors may ask are;
Is the team experienced in the area they work?
How many years of experience/ exposure do the founders have?
What is the level of commitment of the founders and the team? Are they working full time or part-time?
Once they gather satisfactory information about the founders and the team involved and gain a level of comfort and trust, they will be more likely to invest in that startup. Remember, getting an investor on board is only the beginning. It is a relationship that will last a long time to come, hence having a good understanding relationship with the founders and the team for it to be a successful partnership.
‘Ideas are cheap. Execution is everything, is a line well heard of among startup communities. There could be many great ideas, but if those ideas cannot be executed, they are as worthless as not having them at all. Therefore, having a plan on how to execute the idea and being able to well execute it, is imperative for the success or failure of a startup. This is why most investors look for startups and teams which have a good execution plan or individuals that have prior experience in successful execution.
When pitching to a potential investor, this can be shown in the operational plan. The steps are taken in how the execution is done, risk mitigation plan (if any) and overall process in place for successful execution that is well thought of, must be presented.
For startups that may have done a Proof of Concept (PoC) and/or some pilot projects, this can be shown through case studies. This is the opportunity to show the investor how a project was executed, how the team worked together to achieve the goals and objectives, what did the team learn and how did they use the experience to improve their execution in future projects.
Great execution may not come at the beginning itself. However, the attitude of learning, flexibility, constant improvement and willingness to change for the better is all part of becoming great at execution.
It is no secret that investors invest in a startup with the expectation of a good return in an expected time period. What is a good return? On average, investors hope to get at least 5 times what they have invested in your startup company.
Now, this may seem like a big target at the beginning, however, keep in mind, investors are not lenders. Their purpose of investing is not to get their capital returned with an interest. Their main objective of investing is to significantly increase the capital, which is why they spend more time in understanding the startup idea, the team involved execution strategies etc. prior to investing.
Unlike lenders, investors may invest more in a startup, considering its future potential. Which is different to lenders who may look at its current state. Therefore, investors take a higher risk when making the decision to invest. Part of this risk is also the potential failure of a startup, which will result in the investor losing some or all of his/her investment.
As such, being able to explain to the investor how you hope to provide them with a return of 5 times in a set period of time, is important information for making that decision.
This is an important area which most startup founders may not consider, their products ‘Proprietary IP’. Investors are keen to know and learn if the startup has any proprietary IP, such as patents to the idea, product, design etc. which will be beneficial in many aspects.
The most common requirement is to know that once an investment is made that no other external party can claim to the startup product or service, which in turn will make the investor’s investment obsolete, putting them at high risk.
The other reason can be in valuation. A startup with patentable components can be more valuable in the long run as such investors would like for the founders to have a clear direction of maintaining proprietary IP. This will also be useful in scaling or considering other business expansion models which may require such proprietorship.
Scalable Business Model
Startup founders may embark on this journey initially for a purpose or in pursuit of a passion. Whilst this is very important and is a necessity in the success factor, it is also important to think and plan clearly on the business model. Just like one would think of ‘how to make revenue from the business, founders must also consider ‘how to increase the business revenue’.
For investors, this is a clear indication that the founder is thinking in those lines of scaling and growing the business and so is a lucrative investment to make.
Generally, depending on the type of startup, investors would like to see a scalable business model for roughly 3-5 years. This may be fine-tuned yearly, however, the direction the founders plan to take the startup, is very important to investors, when making the decision. Keep in mind, investors would like to have a ‘small piece of a big pie, rather than a big piece of a small pie’. Therefore, your business scalability must be considered in a big market, ideally able to expand internationally.
Not too high valuation
With all these components in place, investing amount is decided based on the valuation of a company. This is a figure that is derived based on many aspects including, the founders’ profile, the validity of the idea, existing customer base, generated revenue, the potential for scaling, revenue projection etc.
While startup valuation is mostly based on its traction and potential in the future, it is important that it not be too high of a valuation. This is because, when the valuation is high, investors have to invest a much higher value per share than its existing value. This makes the risk of the investment higher than it should be.
Therefore, founders must make sure that while the valuation of the startup should be kept higher than its existing value, it must not be too high of a value that could potentially be seen as unrealistic.
Investors are not interested in taking over your startup. It might surprise you that their objective is actually the exact opposite. Investors look at investments, which will bring them the expected X5 returns in roughly 3-5 years time so that they can make their exit.
As such, most investors define their exit strategy at the time of investing. This is important to both the investor and the founder so that they can be very clear in their objectives and requirements and plan to achieve them in the planned timeframe.
The above 7 key investor expectations, will give you as a founder a clear idea of what you need to say, show and demonstrate when pitching to a potential investor. Having an investor on board will be an important decision for both parties. It is a relationship in your startup journey that could be the success or failure factor. As such careful consideration and taking the required time to help your investor understand you, your startup and the overall vision will help make it a worthwhile partnership.