Investing in Tech Startups: A Short Guide
So, a master going off on a trip called his three servants. He gave them all a specific value of money. Two of the servants doubled the master’s investment. The third servant carefully buried the master’s money. The first two were rewarded by being the master’s partners. The master was furious at the third servant.
Yes, investing bears a lot of risk, especially if you’re investing in a tech startup! However, a great deal of choice counters the risk. Unlike what the adage claims, investing does not resemble gambling at a casino. If you play your cards right – pun intended! – you’ll be able to generate a high return rate, and escort the startup all the way to its exit stage (hooray!).
Whether you chose to be an angel investor or a Venture Capitalist, there are specific factors you should look into prior to pumping your money into a startup’s engines – the team, the idea, and the business model. Backing your decisions with solid research is how you nip the risk at the bud.
In this piece, we’ll be highlighting the key principles of investing in tech startups, and we’ll be sharing with you what some investors have to say about it. Enjoy the ride!
Establish Your Identity
If you travel back to the classics, you’d realize that one of the golden rules of investing is to define your investing persona: what type of investor are you? For example, the father of investing, Benjamin Graham, mentioned in his timeless comprehensive guide, “The Intelligent Investor” that there are two types of investors – the defensive and the enterprising. The latter is ready to commit and diversify, the prior sticks to average investments.
Now, how is this applicable in the world of tech startups investments? First, you need to define the startup stage you’re interested in: pre-seed, seed, or growth; a startup functions according to a well-defined life-cycle.
Doing so indicates the category in which you’ve positioned yourself as an investor: angel, VC, etc. Each type of investor follows a specific investment process, and differs in check sizes (investment ticket) and accountabilities towards the startup.
Keep a Colorful Portfolio
The majority of startups face difficulties to keep their boat afloat; most of them end up capsizing. The aforementioned metaphor points at the high failure rate startups are daunted with. Or, according to Forbes Magazine, 90% of startups are to meet their demise; the statistics are gruesome, but relevant to you – the investor.
Tracing back the classics, again! Based on Graham’s intelligent investing principles, a smart investor should strive towards dividing his portfolio among different asset categories – adopting an asset allocation strategy that widens the probability of an increased return on investment ratio.
For a tech investor, Graham’s asset allocation rule applies as well, especially when investing in tech startups. As mentioned earlier, survivorship is a daily challenge that startups have to face; the reasons are plenty: the absence of the market need, poor technology validation, incompetent team, etc. Therefore, as an investor it is better to be safe than sorry; diversify your investments, and don’t base your portfolio on that one startup.
Be Vigilant of the Atlas
Atlas cannot shrug; if he does, the earth would fall. In investment world, Atlas is the team, and the earth is the startup.
It may come as striking, but team trumps idea! As an investor you should research the team’s capacities and understand its potential, prior to anything else. The team carries the heft of a startup, especially in the early stages; every member plays a critical role! Zafer Younis, a partner at 500 startups, an early stage fund, told us that “the team is the utmost importance; we value commitment, experience, and chemistry between founders”. He added “we firstly look into the team’s ability to execute and take tough decisions.”
Given that the market is characterized by frequent shifts and wild fluctuations – especially the tech market – a startup’s team should be able to positively absorb these sudden alterations, and consequently pivot from the original idea to a new one that caters to the change. Sonia Weymuller, a partner at VentureSouq, an angel network, explained to us that the question is “whether or not the founders will be able to put their egos aside to pivot, if necessary.” So, one thing to keep in mind is that a successful team is resilient to vicissitudes.
Building on the ever-changing character of the tech industry, a tech startup team should be thirsty for knowledge and in-tune with the latest trends that are altering their business’ technology.
Aside from the above, the team should be experienced and specialized – there’s no room for rookies! The aforementioned rises to a whole other level, if the idea requires advanced and complex technology, not only reconfigured. A startup’s team should be well informed about the business they’re navigating in, as Nabil ALNoor, , President and Managing Member at Graphene Ventures, a Venture Capital firm, underlines that “the team’s competence to deliver collaboratively” is key in that context.
Investigate the Idea
Ideally, a startup is the creative answer to a problem or a pain-point that a specific demographic is suffering from. The developed technology should be able to solve the problem – viable technology. In that context, find below the essential questions that you should ask yourself as an investor before taking your decision:
- Does the idea bear any value? (Does it address a problem and solve it?)
- Is the product market-fit?
- How big is the market for the product?
- Is the technology accessible/feasible?
- Is the technology original, as opposed to being reconfigured?
- If the technology is reconfigured, what is its value proposition? (Competitive value)
- Is the business model sustainable?
A startup should know how to answer these questions, as they should guide your decision in the right direction. Or, Zafer stated that “a good way to assess the startup’s product is by looking at its users’ data […] moreover, other factors such as the total addressable market, the value proposition, the business model, and the scalability are also as important.”
A Note to Your Investor-Self
Making investment decisions does not include any sort of fortune-telling activity. Albeit risky, choosing to invest in a tech startup entails a whole lot of research. Irrelevant of the technology you’re presented with and the life-cycle stage, you should always gear your investments towards a nimble and lean team, a brilliant idea, and a sustainable business model. For VentureSouq it’s all about “the business model, the team’s profile and efficiency, the product’s USP and backend, the market size, and the competitive landscape.”