How to evaluate an early stage startup before investing?

  • Investing in startups as a novice investor can be tricky. Complicated jargon, technicalities, and whatnot! 
  • What are the major factors to consider while evaluating a startup before investing?
  • This week, Khushdeep Sethi, Content Strategist, 1stCheque by Favcy is decoding startup evaluations for you!

I bet that’s a question a lot of you must be asking, especially if you are beginning your angel investment journey. The short answer is - there’s no set rules or foolproof methods to evaluate your deal flow with a guarantee for success. And hence the first rule of investment is to diversify to reduce risk (we covered this last week). 

What we can focus on are guidelines that help us assess an early stage startup opportunity.

Being on  the receiving end of the pitch, it's easy to get swept up in the founder's unwavering passion and belief in their startups (we are all guilty of this).

Here are few important factors to consider before backing a startup - 

The founders

The founders are one of the most, if not the most important, factor to consider before investing. Do they have the skills to execute the big projections they are placing in front of you? Are they passionate about the product? Get to know them on a personal level. Learn about their background and experience. Second time founders are definitely a safer bet (they know their mistakes). The initial idea may not work post launch and a 360 degree pivot may be needed. The founders should have the mettle to execute that. Founder coachability is another important criteria to look at.

Untaken positioning within a large TAM - 

As an angel investor, you would want to invest in opportunities that have exponential potential to scale. That is only possible if they are operating in a large potential market. However, being in a large market also means a lot of competition. An early stage startup’s best bet to gain early traction even with frugal capital is to launch in an untaken position. 

Clarity on Revenue Model - 

Ask this question upfront - how are you going to make your money? Who is going to pay you and what’s your revenue model? It is important to assess what are they going after - customer acquisition (with loads of marketing moolah spend) or revenue generation from day one. The latter is ofcourse preferable. Then, you can check if the revenue model has any recurring elements. A recurring revenue model is definitely a more sustainable way to build a business.

At Favcy, our portfolio startups undergo a rigorous evaluation process before they make it to the table. We initiate our evaluation based on differentiation and relevance of the startup called the DREK exercise. This is followed by a rigorous business model evaluation and only startups with above a certain threshold of LTV:CAC ratio are considered further. Additionally, we have mechanisms for evaluating founder-market fit and product-market fit and only startups with products/solutions targeting an untaken position in their respective markets are considered for selection. 

We make all these findings, along with our thesis (why did we onboard a startup on to our portfolio) available to our investors to help them make informed decisions.

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