When looking at equity funding, be it crowdfunding or as a business angel there are a few fundamentals that need to be considered in order to identify the risk and reward profile of the investment. It should also be remembered when compared to VC’s retail investors take all the downside risk with their own money, whereas most VC’s get paid 2% of AUM and 20% of performance fees with someone else’s money.
For a business to be sustainable in the long term and generate a return for investors its must be able to generate revenues and positive cashflow. A basic question that I have when I look at an investment is, would I buy the product and use it, or if it is not targeted at say my age, would my cousins’ kids buy it and use it. If it doesn’t tick one of those two boxes, I pass on it.
Early stage funding is valuable, and financing is one of the biggest risks to early stage. For an early stage company to get growth and critical mass the product needs to be scalable with a high contribution from sales. Having to spend on infrastructure to scale in the early period can divert time, focus and funding away from securing the home market. The second level funding is easier to obtain as growth capital than another round of MVP or research capital.
High margin products, especially with a SAAS type or monthly recurring revenue give better multiples on future funding or exits.
Marketing plans and execution
Digital marketing has become the norm which can, if used correctly be cost effective, or if used poorly be a drain on funding with no tangible results. Speak to the marketer, if they are focused on impressions and reach give it a pass as you can not buy a beer on a Friday night with an impression and reach, make sure that they are targeting conversions and know the targeted ROI on marketing spend.
If the business can demonstrate ROI in marketing spend it is also a lot easier to raise supplementary funding as the return can be modelled for new investment. If you can tell an investor for every 100 GBP you put in we get a return of 300 GBP in revenue and margins are high, you have a good story.
What’s the team’s motivation?
Are the team looking to make a good return and exit, or are they looking to become a unicorn? Are their objectives realistic given the business and sector?
As an investor you want at least medium-term liquidity and if the team are in it for the long term and the unicorn dream, you can be waiting a long time and never get an exit. Big dreams are great, but reality is more important, a 25m exit is very good if the founder still has 25% of the equity and the investors are in for a 3 , 4 or 5x.
Experience of team
It’s good to have a team with experience and at least one member who has some grey hair and miles on the clock in the start up space. It is not easy to build a company, it can be stressful and need strategy and sanity when times are hard. A team member who has been through that before can be a good influence and take away some of the risk.
Make sure that the company has a product that there is or will be a demand for, preferably scalable without having to spend a lot on infrastructure and expansion. Ensure the team have realistic expectations of exit and have processes in place to measure execution of plans especially in terms of marketing spend.
If the team cannot or will not answer questions on these key points, move on to the next one.