My approach in finding good startups is a more a metric based than an intuition based (it is not a gambling, right?...for most of investors...i hope :) )
What are those key metrics you find really helpful to validate startups. Do you have a formula defined for yourself?
Business Model - can it make money?
Are the people running the business competent?
Having invested in half a dozen start ups the latter is most important.
The right people will change and change until they will make the business work.
But with the wrong people evn the right business model will fail
Risk adjusted ROI.
There is a lot that goes into such a calculation, but the three primary categories are:
- People: Are they a functional team
- Process: Do they have and believe in processes
- Product: Does the product sell for a profit
Hi, perhaps I can help as I have advised investors to invest for some 20 years and then switched sides and helped companies to raise funds for investment. I still sometimes help some "sophisticed" investors (as we call them in the UK, so Angel investors, those who have invested before in young companies and know what they're doing) and drill down to the essentials. I basically go through even the best business plan and find faults with it - not to say we won't invest, but it's good to see how the CEO copes under pressure in a presentation if you throw something (even ridiculous) at him. The CEO needs to be able to think on his feet and provide some kind of sensible answer.
The team need to be trustworthy with a good, reputable, background, preferably in what they are wanting to do but not always essential if they can explain that away. They must be able to look into your eyes and tell you the god's honest truth, warts and all.
But before we even get to that point we need to look at what they've done already. They have to made money. They have had to have the ability to turn a $10 note into more than $10 after accounting for costs and everything. They may be asking you for money based on a prototype and that's always a tricky investment decision as you don't know whether it will sell yet, so I would always recommend in that scenario that you pledge the money they need but drip it in to them.. Ask them how much it would cost to sell just one (or maybe a minimum amount amount). Give them the money for that if they have convinced you their product is the best thing since Bitcoin and then you can get a profit/return per unit. But I mean an ACTUAL profit because more often than not theoretical profits are way off the mark.
I am interested in the metrics that you do use? Would you be willing to share?
Georgi, I really really don't think you can do it with metrics.
There are two elements:
1. How likely is it the company will survive to achieve break-even cash flow or an exit to dumber (or smarter) money.
2. What valuation and terms are you buying in at.
I will be interested to see what others say. But it is hard enough to use formulas with publicly held companies. Startups with no history? Sort of hard.
Curt Sahakian, Esq.
truCrowd, an SEC/FINRA licensed Regulation CF Equity Crowdfunding platform
Chicago / Los Angeles
Metrics and financial projections mean nothing without a competent business plan that support those projections. Most startups do not have an adequate business plan that evolves...and most fail, in no small part, for that reason.
a good rule of thumb is you need to make an obvious connection between you investment and a return back to easily besting 10X. this interest is no more complicated than "easy money". so they should be easy, but also have "the goods". frankly, if you can add up spreadsheet stuff about their growth and it isn't astounding? it's hard to get anywhere worthwhile. I find that innovation can be measured more usefully than financials. If a startup has 'the goods' ? they can make a lot of mistakes and still achieve a lot. if a startup is just another word for 'small, newly founded company' then reviewing financials won't much reveal those who can return big returns
There are several metrics and they depend on the structure of the business model. Feel free to message me for further info. I wlll try to condense the answer to keep it readable.
First of all, a lot of investors will say...its all about people. Which is true, but it is a missed opportunity not looking at financials. I will tell you in a bit why and how. First consider the perspective of an investor.
Most investors do not make money. Some make money but if you take into account the risks they take and their return they could better stop doing it from a statistical standpoint of view. Few do make money and some of them have large returns. More than once, when you review their investment, it almost looks like a ponzi scheme. Investor 1 invest, they scale up to fast, tell everybody how great they are, Investor 2 gets interested and invest at a higher valuation, hence, Investor 1 has made a profit. Either on paper or when they cash out they have their profit in the bank. Think about WeWork as an example.
Out of each 10 investments, 8 to 9 will fail. Suppose you want to have a return of 10% each year and want to see that return in 5 years. The math is you will need to invest in startups that can at least return around 16 times your investment. so suppose an investor invest 500k for 25% it means a company value of 1 million. This startup needs to have the potential to be valued at least 16 million within 5 years. Otherwise, the one out of 10 that makes this 16x return in 5 years will not make up for the losses in the other 9.
Suppose now that not 9 but only 8 investments will fail. For instance, by being better in selecting the promising startups or being better in focus on what makes a startup a success earlier in the process so the startup has more time and funds to do it right. In this case, 16x will drop to 8x. So the same startup of a million needs to be valued 8 million within 5 years.
As you can see. It is all about numbers. So yes, financials are important at the start of any company. Nevertheless, it is easier to stay away from them because it is complicated. Complicated because it is nothing like an average P/L forcast. So most will say...does not matter it is all about people.
We have been working hard on modeling the dynamics of startups. In our model you fill in assumptions and the model will dynamically build financial projections over 3 years. Important to note here is that the model does not have any assumption about number of customers each year. The model ask you to fill in assumptions about your sales funnel, available constraints like time, investments and their frequency, growth per week and some more. With a push of a button you will see exactly what will happen. How much capital you need to get cashflow neutral and what the return for the investor will be in 3 years time.
Are these numbers the truth? Will those numbers hold as soon as the startup starts doing business? Of course not. As soon as the startup starts, it will see that some or all assumptions where wrong. The beauty is that from the start everybody did an educated guess supported by reasoning. When over time the assumptions change, so does the model and you will see if this is a good or bad sign and you can act on it. Quick and focused.
Lastly a note about time. Time is lost because of to little actionable information at the beginning of a startup. Is a CAC of 300 bad or not? If it could be 200 dollars it is bad. But how bad? Is a growth rate of 1% per week bad or not? And if bad, how bad? You need to know where to focus quickly because of the following.
Suppose you have that investment of 500k. it is enough for 18 months which will give you a runway of 27.777 dollars each month given an equal distribution. Suppose that you figure out in 3 months which numbers are wrong and how bad it is and where to focus. Thats 83.333 dollars gone and also 3 months closer to running out of funds. each month quicker will save 27.777 dollars and gives an extra month of time to get to cash flow neutral.
A lot of startups and teams fail to reach profit quickly enough because of too little time and or funds. So yes. Numbers are important.
Feel free to reach out if you want to model more or model a specific case.
While @David M is quite right that a well-considered plan is more important than a specific metric, what's "good" has a lot to do with your risk tolerance and personal interests.
Investing in startups is rarely about a formula. If you want formula, invest in the stock market, not startups. You're clearly looking for something else. And it sounds like your "validation" is about reducing specific risks, not about finding the "good." Is a company that needs $1million and will return $3million a "good" company, or is a company that needs $25K and will change the lives of many people for the better, but only return $35K "good?"
Your investment goals play heavily into your subjective label.
If your metrics are only meant to ensure you don't lose money, you're a strange investor not to have goals, but good for you for being even-handed with your investments. Evaluating risk is not a simple formula, but there are key indicators as to what amount of support (besides money) a startup will need in addition to funds. One of my first questions is always, "What will your company be doing if you never receive any outside funds?" That should tell you a lot about their ability to act conservatively and in understanding where they should really be focusing.
Very helpful information, thanks for sharing
From the point of view of Impact Funds, the key metric would be Impact (Social or Environmental or any other area of Sustainable Development). There are many different approaches to measure long-term and Sustainable Impact, for e.g. Social Return on Investment (SROI). Of course, validation cannot happen based on track-record for startups. It will be more of predictive/forecast analysis.