A recent poll found that 54% percent of Americans invest in the stock market, either through individual stocks, mutual funds, pensions or retirement plans like a 401(k). But less than 1% have made an angel investment.* Why is that?
Because not many people know they can. Platforms like Republic are fairly new, and we provide everyone––regardless of accreditation status––the chance to invest in highly vetted, private companies with as little as $50. Angel investing is risky, but to achieve a balanced portfolio it makes sense to allocate a small percentage to this asset class.
Diving into startup investing can also just be overwhelming. So we’re putting together a blog series, “How to Hack Angel Investing,” to share some tips and best practices to get you thinking like an angel investor.
In this post we’ll consider important criteria for evaluating startups. We call them “The 4 Ts”:
It’s not an exhaustive list of criteria, but hopefully it guides your diligence process as a budding startup investor.
The expertise and passion needed to solve the problem
Founders are critical to a startup’s success––or failure. Their prior career and industry experience should add up to a set of skills and expertises that helps them execute their idea, build a team, and inspire others. Ask yourself:
Do the founders understand the market better than anyone else?
Are they intensely passionate about the problem they’re solving?
Can they clearly articulate the need for their company?
Do they demonstrate leadership qualities, like the ability to inspire people?
Do they have the resilience to overcome the many obstacles that entrepreneurs face?
Signs of growth and market demand
For consumer-focused startups, a passionate and engaged user base is evidence of traction. For enterprise companies, a robust client pipeline and actual revenue is the name of the game. Keep in mind that traction alone doesn’t indicate financial health or wise financial management. Ask yourself:
How many users are there and what percentage of them are coming back every month?
How much revenue has the startup earned? Is it increasing each month? Each year?
What’s their sales and marketing strategy?
How do they plan to acquire clients?
Do they have any name-brand clients?
Innovation meets execution
Startups should leverage technology to create valuable and innovative solutions to real world problems. Once you’re convinced of this, you can start evaluating the solution by understanding their strategy to build a solid product. This includes their product roadmap, design, and UX. Their product should also have a leg up on the competition. Ask yourself:
What is the problem, and is it worth solving?
Is the product 10x better than existing alternatives?
What is their secret sauce or unique technological solution to the problem and can it be patented?
Making sense of investment instruments and deal terms
Central to evaluating terms is understanding which instrument you’re using to invest, the company’s valuation, and how your investment--or equity ownership--could make you a cash return in the future.
It’s common for established angel investors to get equity (i.e. preferred shares) in a startup at the time of investment. Most angels use investment instruments such as the SAFE, Crowd Safe (created by Republic), or a convertible note, which all convert into equity at a later date. These instruments save time, eliminate most legal fees, and allow early investors to postpone agreeing on a valuation by converting to equity only after there’s a priced equity round. Regardless of the investment instrument, ask yourself:
What’s the valuation of the company now, and what is the valuation cap, or the max valuation that your investment will convert to equity at the next financing round?
What is the discount at which your investment will convert to equity in the next financing round?
Are there pro-rata rights in the agreement (the right invest in the following round to maintain your ownership percentage)?
When startups IPO (like Facebook in 2012) or get acquired (like when Amazon bought Zappos in 2009), there’s often the chance for investors to make a return for their equity ownership––in cash or common stock.
Stay tuned for more!
We hope this overview is a good starting point and encourage you to dive deeper with us on future blog posts and webinars.
*Gallup, Angel investor estimates cited by the Angel Capital Association