Before You Invest in a StartUp

By Leland Baptist, - In Money

Picture of a business owner at her checkout

Photo Credit: stockphotosecrets

Investing in a company is a huge commitment. Not only is the investor committing but so is the entrepreneur. Many shows can over simplify the task of choosing a strong valuation for the prospective company or entrepreneur an investor is looking into investing. Whether you are an employee, investor or potential partner here are a few things to keep in perspective before you take on the task of business.

Our Parent company consultants conduct valuations of the prospective businesses to be acquired. Here are a few things that we look closely for;

Entrepreneur: Is the entrepreneur vested in the company? Knowing if an owner is willing to put his or her all into the company is a big sign of that person’s character. If the owner has the true desire to make that company become more than what it is today.  A good identifier is to find out how much resources, capital, material and sweat equity the entrepreneur has placed into the company. Unfortunately there have been some business owners who have asked me to deploy our management team and capital into a dream that he/she have not been fully committed to them self. I label this type of entrepreneur as someone looking for a “job” not an investment.  If a business owner is able to start a business one month and then three months later has suddenly decided to procrastinate by placing their dream(s) on hold. This is a sure sign that even with your capital, talent and expertise they would do the same to you. Why?? Because if they hardly respect themselves to push through with determination out of the desire of financial freedom for themselves, how can you expect them to achieve financial goals on your behalf? If they can’t respect themselves they won’t respect your time or money. A person like that will often have to be micro managed, causing you to be more of a supervisor instead of a business partner.

Management: This is different from the entrepreneur. If you are an Investor then the initial owner will be viewed as the CEO or executive. What makes Management different is the areas and practices that affect the business operations. For example, the company may build computers. In doing so they may purchase parts from Asia that take on average 3-4 weeks to be shipped. What is the current management process in place to handle the orders, shipments, sales and packaging? What is the “process” for advertising? Is there a sales funnel for acquiring new clients? Often the current management process is what causes a small business to not be successful. This is the reason that often times in addition to us investing capital into a small business we also add our management team to craft around the weaknesses of the small business owner. Find out what the current systems in place are to sustain the business operations.

Niche: Having a niche is a blessing and a curse. Having a niche for investing purposes is a quick win. This is primarily because you know the precise target market that your product is geared to. This means that your idea, service or product has a specialized but profitable corner of the market. You typically want to aim a company in a niche that is as least competitive as possible. A great example would be a product geared only to a certain demographic such as; gender: women, ethnicity: Hispanic, background: from Southern Florida with married parents, marital status: single, education: bachelor degree, Income: $45-$55,000, entertainment: VH1 and MTV, favorite food, favorite color etc. The more targeted the more you are able to learn about the customer. The more you know about the market, the more you know how your consumer thinks. The more you can identify with the thought process of the customer, the more you are aware of what drives them to purchase. Then you can position your company and product to their desires. Another example of a product with a niche is a product that is for Italian Americans who enjoy soccer. Maybe this product could be a soccer ball with the Italian and USA flag.

Scale/Sustainability: Scale is the ability for the business and business operations to be duplicated in multiple markets. This is valuable if the company goal is to duplicate the success and expand the business. To have company sustainability there are a ton of factors, but a very important factor is relevance and usage. Relevance can be changed if the product is associated with an industry that is parallel to entertainment. Usage is hard to control in an industry parallel to technology where there is constant influx of new products. For an example of a product that will have consistent relevance and usage, think of lotion that is geared toward dry skin such as eczema. In this example, there is a constant need, which will never fully be cured. This makes the product relevant through the adjustment of “common” technology, and stable usage since there is no cure.

Market Entry/Barrier & Growth Phase: As technology increases the ability to create and enter various markets becomes more and more accessible. An advantage for major corporations such as a chemical company is that their solutions are proprietary and thus for someone to compete it would be much harder. If a special chemical component is required to make the Steller product, the primary company can license the technology or slightly dominate the market with slight regulatory movement. This can be a great advantage if the company wishes to dominate their market. Barrier to entry for a new company can be a hurdle and may take the entering company years to further develop to become a true competitor in the market. A good example is a small mom and pop fast food chain determined to replace McDonalds. As an Investor you want the company you are investing in to have a healthy balance of a market barrier and growth phase. Growth phase is the estimated time period it would take to enhance the product or service to superior quality or consumer interest. For example, a clothing company can increase their materials and brand. By adding $10 worth of material, the quality can double and the price can be justified to be sold at three times its original value. This allows a shorter period of time to increase the company and profit margin. You want a market that will allow your company to grow and with minimal barriers.

Financials: Make sure that there is equity to obtain in the business. If the company is already over leveraged, does this mean that you as the Investor will clear the bad debt? If you clear the bad debt will you be able to acquire additional equity? (I hope so.) When will the company be expected to produce returns or dividends to their owners? Will this be monthly, quarterly, semiannually or annually? What will be the company accounting calendar? What is the company capital structure? Will you have access to the financials? Will there be quarterly financial statements given to have a formal checkup and monitor of the company? These are all good starter questions to ask your new found business partner(s). As Investor, you really want the company to grow. During your decision process of investing, you should determine where or what part of operations the money should attack. Money is a servant, and you either control it, or it will control you. In other words you want to control where the working capital goes. For example you can agree to have a 40% equity stake in a company by investing $36,000.00 into the structured company. Yet pick and choose the allocations or earmark the $36,000.00.

Allocation Example:

  • $12,000 – Marketing
    • 33%
  • $5,000 – Service Bad Debt
    • 14%
  • $6,000 – Working Capital
    • 16%
  • $10,000 – Product Enhancement & Branding
    • 27%
  • $2,000 – Website Enhancement
    • 7%
  • $1,000 – Prepaid Expenses
    • 3%

When you invest in a company you’re not just investing into the company but also all of the functioning parts. This is why you want your capital to address the needed parts to produce profit immediately. Make sure that you can get along with your new business partner (entrepreneur).  Have the proper agreements and board governance structure in place.



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      Comments: 2

    1. Ebrima on

      Great article. It is also important to check the management compliance with local regulations. Not only the business registration but licenses and permits. Startups have been closed due to lack of relevant authorities approval. The founders didn’t think about that at start.

      Reply
      • Henry Reith on

        Hi Ebrima,

        Totally agree! It will be interesting to see what happens when the lawmakers catch up to technology as well and to see what happens in the start up world them.

        Love your website as well.

        Reply

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