Investing in tech start-ups is one of the most exciting investment opportunity sets available at present. But the mesmerising potential investment rewards require a combination of many highly specialist skills, says Alexander Selegenev, executive director of TMT Investments.
Skills to analyses opportunities range from a complex assessment of company founders' abilities, to a deep understanding of core technology, alongside the standard assessments of market size, growth potential, uniqueness and scalability.
Whatever the stage, potential investors will need to get comfortable with the following key elements of any investment proposition: people, market, product and money.
People
The types of earlier-stage, fast-growing start-ups that we target operate in extremely competitive and fast-changing environments. This is we look for in an outstanding founder with the ability to grow their start-up into a viable and sustainable business. And this is probably the single most important part of the "magic formula" for success.
The key lessons from Silicon Valley's tech companies
Perhaps surprisingly, even a detailed understanding of the product in these early stages is sometimes irrelevant. There are many examples of how initial products evolve based on monetisation strategies or even "pivot" into something totally different from the original idea.
The market is so fast-changing that a potential crowdfunder in a start-up needs to have detailed knowledge of what is happening in many different industries.
That's when it all comes down to people. For early-stage companies, the difference between success and failure almost always lies with the quality of the founders. That's why the "founders test" is the most critical part of our due diligence.
Unfortunately, this is also where smaller, inexperienced crowdfunding investors are disadvantaged. For example, it is not unusual for crowdfunding companies to offer meetings with founders only to those investing larger amounts (for example, more than £5,000).
We want to see entrepreneurs who have done their homework and done it rigorously. For example, the CEO of a subscription-based e-commerce company in which we recently invested presented such a complete picture of her business (and with such clarity) that we were really able to make our decision to invest within just a few minutes of our initial meeting.
Our decision proved correct: the company is experiencing tremendous growth and other venture capital funds followed in our tracks a few months later at a much higher valuation.
One of the biggest pitfalls is probably relying on one's own experience and preferences when assessing the merits of any particular idea.
Market
Due to the lack of relevant information and the much faster-changing environments in which start-ups operate, the knowledge and expertise required when assessing an investment are often much more demanding than those required for public equity investing (i.e. investing in companies listed on a stock exchange).
What is relevant at this stage is highly sensitive monthly user/revenue data, although it is not surprising that most companies refuse to share that information publicly as part of their pitch.
The market is so fast-changing that a potential crowdfunder in a start-up needs to have detailed knowledge of what is happening in many different industries.
For example, whether the "disruptive approach" being proposed has worked or failed in other markets, what competitors are doing, and whether their alternative strategies are likely to be more successful.
This is a task well beyond the abilities of an accidental crowdfunder who will not have the time, resources or expertise to do this continuously. And even as a professional investor, unless you specialise in a sector, you are very unlikely to be able to identify winners consistently.
The types of earlier-stage, fast-growing start-ups that we target operate in extremely competitive and fast-changing environments. This is we look for in an outstanding founder.
Product
One of the biggest pitfalls is probably relying on one's own experience and preferences when assessing the merits of any particular idea.
"What a crazy idea, I never heard of it! And I don't see why I would ever want to use this product! I have never had this problem, so the problem does not exist!"
But what you personally like should not be relevant when investing. One needs to apply objective criteria, and to do so consistently in order to build a credible portfolio with a higher chance of investment success.
Many people are surprised at how many other people or businesses are ready to pay for services that may be totally irrelevant to them personally.
The other side of the same pitfall is the herd mentality or hype. An inexperienced investor is easily drawn to investment opportunities that happen to be 'hot' at the time (heavily written about, financed by famous people, raising big rounds of financing, and so on). This is not the same as having the best business prospects.
Whatever the stage, potential investors will need to get comfortable with the following key elements of any investment proposition: people, market, product and money.
Money
Valuation is a function of investor demand. We all know fair valuations or "air valuation multiples" is a fluid concept. The task is even more challenging for start-ups, when often there are no revenue (let along any profit) figures to which to apply those multiples.
An experienced start-up investor (who sees dozens of cases every month) almost immediately knows if a particular offering is over-valued based on its stage of development and other factors. Inexperienced investors do not have the luxury of that knowledge.
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