fbpx
News & Analysis

What investors really look for when investing in a startup

- October 4, 2021 3 MIN READ
Photo: AdobeStock
While there are commonalities among their criteria, startup investors don’t take a cookie cutter approach. The key to unlocking investment is understanding the stage of your startup.

“In the race of life, always back self-interest; at least you know it’s trying,” the late former premier of NSW, Jack Lang, once said.

Self-interest is defined as “regard for one’s own interest or advantage, especially with disregard for others… personal interest or advantage”. 

Meanwhile, to invest is to “put (money) into financial schemes, shares, property, or a commercial venture with the expectation of achieving a profit”.

Hence achieving a profit is at the heart of what investors are looking for. They aren’t out to make new friends or reward the bright ideas of others.

What investors want

Achieving that longed-for profit has a few common elements for investors.

A quick Google search for “What investors really look for when investing in a start-up” suggests:

  • A business leader with skin in the game 
  • A unique product or service
  • An established customer base
  • Generally, the unwritten desire to not be the initial investor who supplies the seed capital

In short, a level of confidence is required for an investor to part with their money. 

So just where do start-ups find investors with such confidence?  The answer ultimately depends on the stage of the start-up.

Startup stages

There are well-defined stages of a company, and each has the potential for investors to exist: 

  • Stage I – Existence: the main problems of the business are obtaining customers and delivering its product or service.
  • Stage II – Survival: the business has demonstrated itself as a workable entity. It has grown past the initial start-up stage but has not yet grown to maturity. A business typically begins to enter this stage when it approaches $1 million in total receipts.
  • Stage III – Success: the decision facing owners at this stage is whether to exploit the company’s accomplishments and expand, or keep the company stable and profitable, providing a base for alternative owner activities.
  • Stage IV – Take-off: key problems here are how to grow rapidly and how to finance that growth. 

(There is a Stage V in this model – resource maturity. However, this typically means the business has outgrown the start-up label and become an established corporate entity).

 

Rightsizing investment

According to the US-based Ewing Marion Kauffman Foundation, professional investors are not at the forefront of start-up investment. 

The foundation’s 2019 research showed that:

  1. Personal/family savings of owner(s) makes up 64% of start-up seed capital
  2. Business loans from a bank or financial institution account for a further 16.5%

Combined, this represents over 80% of start-up seed capital. 

It is also worth noting here that business loans are often guaranteed by family assets. The Bank of Mum and Dad (BOMD) – the colloquial term used to describe parental funding – has about $34 billion in loans, making it the nation’s ninth-largest residential mortgage lender

Another source of Stage I start-up funding is less well capitalised but easier to access: bootstrapping.  Bootstrappers need a different mindset and approach: get operational quickly. 

Meanwhile, Stages III and IV are typically past the “start-up investor” stage. They may look to a stock market listing or subsequent fundraising series to fund future growth. But they have already delivered – even if only on paper – profitable returns for early-stage investors.

Therefore, the ultimate answer to the question of “What investors really look for when investing in a start-up” is that strangers most commonly invest in second-stage startups

Yet this investment is often highly speculative, since start-ups at this stage typically lack all or most of the criteria investors use to identify big winners: scale, proprietary advantages, well-defined plans, and well-regarded founders.

Regardless of stage though, there is one piece of wisdom that always rings true – that given to Dougie the Pizza Hut delivery driver: “Work hard… and be good to ya mother!”