Title III is expected to be implemented by Spring 2014. Even though the proposed rules were published for comments for a 90 day period there is still uncertainty as to when this will happen where we would see non-accredited investors also investing in startup companies via equity crowdfunding platforms.
The most important factors that investors should take into consideration when making an investment should be as follows: 1) team (solid experience and great backgrounds), 2) market (how big could the exit be from the returns perspective), 3) Product (does it have costumers or is it generating revenue?).
However, there are many other critical components that people should keep in mind before moving forward with a potential investment. Below is a good list that equity crowdfunders should keep handy.
1. Evaluate the Team
The team is the most critical component in evaluating the startup’s likelihood of succeeding. Remember that execution accounts for at least 98% of the success of the startup. Every cofounder or key employee who owns stock in the company should have a skillset that provides a great amount of value to the long-term growth of the company.
Moreover, the founding team should have a clear vision of and clear goals as to where their project is heading. As a startup investor, you need to remember that the business plan will be constantly changing according to market needs, so the team should be capable of serving the markets demands.
2. Analyze Revenue Streams
After all the success and failure stories that the internet has produced over the last two decades, startups should be considered viable only in the event the company has been able to identify a clear way to make money. The first dollar really counts.
3. Consider the Burn Rate
For the investment that the startup is raising, you should try to figure out if that amount of money will allow the company to accomplish certain milestones, or if they will run out of money beforehand.
Founders’ salary at a seed stage has been a hotly debated subject. Not getting a salary helps increase your chances of delivering on milestones and hiring quality talent instead. I understand that there are founders out there who need to support families, so not having a paycheck every month might not be a viable solution for every founder and that is fine, too. Regardless, as Peter Thiel mentioned at TechCrunch50, the CEO should never have a salary of over $125K.
4. Competitive Advantage
The startup needs to have a clear competitive advantage over the other companies that are competing in the same space. Without this, the chances of success will be minimal. For example, Google was not the first search engine to launch, but their search results where much better and narrower than those of its competitors. In addition to the product itself, other competitive advantages, like key strategic partnerships, is important.
5. Market Size
Even if the team is incredible and the product is fantastic, the market still needs to be big enough to give you good returns and to provide a potential exit or liquidity event down the line.
6. Dig Into the Financials
In a startup company, it is very hard to get the financials right. Nobody really knows where the startup is going to be in five years, as startups can pivot overnight. However, financials will help you to understand the rigorousness and discipline that the founding team has around their business. The section where you want to pay special attention is the one that references the break-even point. That’s the time where the startup expects to start sustaining itself without the need of additional capital to survive. Additionally, the use of funds section in the financials will let you know how grounded the team is with regard to expenses that they anticipate.
7. Legal Structure
Typically, there are two ways in which you participate in a startup as an investor. One will be via convertible notes and the second is via the purchase of equity in a priced round.
A convertible note essentially is an instrument of debt that will be converted into equity at a later stage once, there is an institutional round that has been priced by a trustworthy VC or super angel. Without a doubt, this is the quickest way to close a round of financing for a startup, as there is really not a lot of terms to be negotiated. As an investor, you want to look for the interest that you will be receiving on a yearly basis and the discounted price on the next round. Additionally, sometimes there is a cap which sets the limit for future valuations when the debt that you purchased converts.
On the other hand, participating in a priced round can be a little bit more tricky, as there are different terms and voting rights involved that need to be negotiated between the investor and the startup. In a priced round, there is a need for a lead investor which will be the entity or individual accountable for establishing a valuation. For this you want the person or entity to be trustworthy and respected in the space so that you know you are getting the right value for your money.
8. Question Its Scalability
The less employees needed to output a meaningful volume, the better. This will decrease the burn rate and increase the chances of success. It is all about creating a “wheel” that, with money, turns faster. This type of models applies especially to digital companies.
9. Determine The Traction
Traction is the word every investor likes. It is an excellent indicator for showing how the market is responding to the product. Review the most important KPI’s to see the type of growth that the startup has been able to achieve over the course of the past few months in operation. It is definitely a plus if customers are so excited about the product that the word of mouth is one of the key components in driving such growth.
10. Understand The Industry
Understanding the industry or having some kind of expertise in the space will give you the advantage of not only understanding the opportunity better, but it will also give you the chance to mentor and guide the founding team in the right direction.