Nowadays, investing in startups and SMEs is very tedious and time-consuming for any investor as each of them have their own criteria and steps to eliminate those opportunities that do not suits their investment strategy.
The goal of an investor is to identify an investment opportunity that matches his or her interests, skills and capabilities. In addition, the investor should also find the best positioned project in order to get the best and fastest return. To do this, the investor relies on decks, business plans and pitches from dozens or even thousands of startups.
It is not an easy job!
Here are 5 steps that some known investors take when first analysing an investment opportunity and also the conclusions of some researchers’ work on the behaviour of Business Angels with regard to the evaluation of investment opportunities.
1. Sources of “inspiration” or how to look for good deal-flow?
Experienced investors build their own network and makes themselves known so that the deal-flow reaches them and they can also carry out the necessary checks.
Investment opportunities can also come periodically through platforms such as Fellow Funders. These forms of sourcing reduce the time spent on searching and first evaluating the investment projects.
This does not mean that investors do not make their own filter but that finding projects throughout reliable platforms or by media can make the identification and evaluation process easier.
It is important to highlight that investors are looking for an entrepreneur who is competent and therefore referenced by his or her network. When investors choose to invest in a company, they are likely to spend a lot of time with that entrepreneur and they will want to know if it is worth the time and energy they are going to spend before any further review of the opportunity.
However, experienced investors are invaluable assets in taking a business to the next level of growth. Personal relationships and a committed network make all the difference in laying the foundation for success for both the entrepreneur and the investor.
2. Viability of the business plan
Once the opportunity has passed the first evaluation filter, an investor will initiate an in-depth analysis of the business model and the overall opportunity.
According to Professor Stevenson of Havard Business School, the entrepreneur’s business plan is often less relevant than the business model (purpose, processes, how it creates value for the customer, how it is monetised, etc.). While the business plan generally focuses more on the execution of the model, the business model provides a more strategic basis for the company’s operations.
Any investor with experience in the nature of the business or industry sector of the project may see the viability of the opportunity from the business model, regardless of the proposed execution.
According to Professor Magretta of IESE Business School, entrepreneurs must be careful to develop a business model where the narrative (how the business is better than its competition) and the company’s financials make solid business sense.
At this evaluation stage, a viable business model should attract the interest of an experienced investor as it will be sufficient for them to consider what experience, knowledge, skills and capabilities they could bring to contribute the growth of the business.
3. The contribution of the investor to the company
Once the viability of the business model is confirmed, an investor will then consider what value, apart from a financial investment, he or she will bring to the business. The investor will assess how his or her personal experience, knowledge and networks could improve the business opportunity.
An individual investor or business angel generally takes a practical approach to investing and will therefore serve as a mentor to the selected entrepreneur. That is why many Business Angels consider the time they dedicate to the project as a non-monetary contribution; not only contributing to the success of the company, but also to the personal growth of the entrepreneur.
Entrepreneurs also need to evaluate investors on the value of their contribution to the growth of their company.
Financial resources are essential, but so are experience, knowledge and networks. A Business Angel must be willing to invest time to help the founder grow as an entrepreneur. That is worth much more than an investor who only provides money.
4. Strengths of the entrepreneur/founder
Considering that an investor will invest time and money in a new business, he or she will want to make sure that both are well used. Therefore, the entrepreneur will be analysed by the investor who will look to see if the entrepreneur is ready, capable and trustworthy. The feeling is another important aspect that the investor will value.
These soft skills are essential factors that can make all the difference. For this reason, many investors fail to follow through with the opportunity.
When making a presentation, the entrepreneur should be extremely well prepared to discuss all aspects of the business opportunity… and in great detail.
Expert investors will look for these details to determine the knowledge and understanding of the opportunity presented by the entrepreneur. This pitch and the Questions and Answers game form the cornerstone of the evaluation process.
5. Exit opportunity
Finally, experienced investors will want to know the company’s exit plan.
Investors will want to know how they will get returns on their investments in time and money. As IPOs have declined significantly, investors will want to know about other exit options such as acquisition or merger with a listed company investment.
According to a research conducted by Professor Joseph Bell of the University of Arkansas, the average Business Angel is looking for approximately a 27% Internal Rate of Return (IRR) or a return of 2.6 times their initial investment (median: $75,000) within approximately three and a half years.
Indeed, it looks like a good return on investment but experienced investors look to further maximise their investment based on the time they will spend and the valuable contacts they will present to the entrepreneur.
Entrepreneurs should have a well-designed exit strategy as part of their overall plan and business model as, in this way, investors are informed in advance of a viable plan to achieve an exit which makes them more likely to commit to investing in the new company.
In the exit strategy entrepreneurs must also incorporate the risks and the realistic probability of failure since all the possibilities must be reflected when framing the possible exit opportunities.
As you can imagine this list of the different steps in the process of evaluating investors in the initial stage is not exhaustive.
However, fellower, we hope we have provided you with some insights into how an experienced investor performs their assessment for an investment opportunity.
Good investment!
Stephan Maisons
Fellow Funders Team
