10 Questions to Keep Before Investing in a Startup

10 questions to keep in before Investing in a Startup

Summary

Investing in startups in India might be beneficial, but it is risky. A new company’s success is not guaranteed, and investors may lose everything if it fails. Before investing in a business in India, angel investors, venture capitalists, and those who use crowdfunding platforms must ask several critical questions regarding return on investment ratio, where to and why to invest, etc.

Intro:

Startup and small company investors make wise investments.

Even when the brightest possibilities emerge and a quick reaction is required, they are extensively vetted first.

A competent investor would have their methods of analyzing prospects, but most would agree that some degree of gut feeling will always be there in the choice.

Recognizing the return on investment ratio:

The return on investment ratio (sometimes called “return on assets”) is a profitability metric for small enterprises that measures a business’s performance or expected return. ROI divides investment return by original investment cost.

What is the Return on Investment (ROI) Ratio?

ROI is a returns ratio, usually represented as a percentage, that allows a business owner to measure how effectively the firm utilizes its overall asset base to create sales. Total assets comprise all current assets (cash, inventories, and accounts receivable) and fixed assets (plant, buildings and equipment).

If an investment has a low ROI, or if an investor or company owner has alternative chances with a higher ROI, evaluating the ROI values on the various opportunities may help them decide which investments to make for the highest return.

Because of its adaptability and simplicity, the ROI statistic is popular among analysts and investors. It essentially serves as a rapid indicator of an investment’s profitability, and it is simple to compute and comprehend for a broad range of investment kinds.

While it is always essential to seek counsel and do thorough due diligence before investing, the following questions are often asked:

1. Does the management team have the necessary expertise to carry out the idea?

In an ideal world, the startup’s management team would be the alchemists who convert their entrepreneurial concept into gold. Management teams are often unable to realize their creation’s full potential. You must examine what fundamental capabilities the company needs to flourish – and if it has or will possess them.

For example, a tech business with cutting-edge software competence but no commercial experience is unlikely to fly. Similarly, a shop with superbly promoted items but no one with the financial skills to manage the bottom line may flounder.

2. What is the required degree of participation?

The obligations that come with investing in a startup increase with it. For example, people who invest in companies via venture capital firms will have little interaction with the company’s management team. Angel investors, on the other hand, have a distinct perspective.

Investors that make angel investments get an ownership position in the firm, allowing them to participate in decision-making alongside the startup’s leadership actively. Unlike an angel investor, someone who finances a business’s crowdfunding campaign obtains stock but does not influence the firm. 

3. Are there plans to fill the team gaps?

Management teams are likely to be a work in progress. Gaps will be seen at this early stage, which is entirely normal. But how certain are you that the essential holes will fill when they arise?

Furthermore, the founders must demonstrate a readiness to welcome new members to the management team and delegate part of their responsibilities to others.

4. Is there a timetable?

For every sudden success story, it takes years for many firms to earn a profit. Investing is a long-term game, but you should know the timeframe to compare it to your expectations. Depending on the investor, they may be content to wait ten years for a return or demand their money back in five years.

Evaluating a startup’s track record makes estimating its investment horizon simpler. The burn rate of a corporation might give insight into its potential. The quantity of money spent each month might provide information about the company’s prospects. If a firm is still in its early stages, yet the burn rate is extraordinarily high, it might indicate that investors will have to wait longer for payment.

5. How does an investment affect diversification?

A broad investment portfolio is the characteristic of a successful portfolio, and the main goal is to minimize risk while increasing profits. When contemplating startup investments, investors must assess how startup investments influence their entire asset mix and risk level. However, achieving the correct balance between risk and reward may be challenging.

When there are clear boundaries between asset classes, it is simpler to disperse risk among them. Because it is more of a hit-or-miss situation, starting a business requires a different attitude. Investors that make more startup investments are more likely to accomplish their goals. 

6. What is the projected return on this investment?

In addition to assisting entrepreneurs, venture capitalists are often driven by the prospect of profit. Analyzing the probable return on investment (ROI) associated with a specific business is essential for investors looking to maximize profits. Because there are many sorts of assets, the returns vary.

Angel investors may often anticipate yearly returns of 30% to 40%. On the other hand, venture capitalists are risk-averse and expect a more significant return rate. Equity crowdfunding is a similar investing technique, and since it is still a relatively new investment method, it isn’t easy to establish an average return rate.

Remember to include investment expenses and fees when calculating returns. Annual management fees may apply to venture capital investments. Crowdfunding sites also charge fees to investors. 

7. Is the team aware of its market?

Misreading the market might be fatal for your company – and your investment. Some businesses may want to do something novel in a market in which they have already become established. Others may have minimal expertise in the target market but have figured out how to disrupt it. 

8. What is the market situation?

Among the most appealing options for investors are those involving firms such as:

  • Entering a market that is experiencing tremendous, all-around growth
  • Targeting a market that is ripe for disruption and in desperate need of a fresh strategy
  • Creating a whole new market, fueled by client desire for something fresh

Suppose an opportunity does not fit into one of the categories mentioned above. In that case, it is not inherently undesirable, but it might be a significant check in the box if it does.

9. What is the size of the prospective market?

Do your research while also listening to the company’s evaluation. There are several ways to estimate market size, but three significant areas of attention include:

  • The Total Addressable Market (TAM) is the total feasible market for a product or service, assuming no barriers to client acquisition exist.
  • The Serviceable Available Market (SAM) examines the demographics addressed by the TAM.
  • The market, as mentioned above, share (SOM) that the company may reasonably anticipate enjoy

While all are necessary to comprehend, the last is likely the most crucial for the investor.

10. Does the exit plan sound?

Startups need to have a well-defined exit plan in place. Before investors withdraw their funds, the original investment and any related profits should explicitly specify. When an angel investor startup buys equity shares, they want to know when they may sell them. It is also critical to understand the duration needed to depart at a moment that is comfortable for you.

Bottom Line

Investing in Startups in India is a terrific method for investors to diversify their portfolio and contribute to an entrepreneur’s success; nevertheless, it is not a risk-free endeavor. Even if a firm has solid cash flow estimates and a solid return on investment ratio, what seems good on paper may not transfer to the real world. Therefore, investors should properly examine a startup investment; they cannot afford to ignore this phase.

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