Note: Post may contain affiliate links.

How to Value Startup Investments

How to Find the Best Startup Investments in Equity Crowdfunding

We’ve seen how startup investing can rocket your portfolio returns with an average annual return of 27% reported by angel investors but with that high return comes the high risk that a lot of investors don’t understand.

In fact, less than half of startup investments return more than you paid in and about one-in-ten account for 80% of your returns.

This is an investment you NEED to know how to analyze, how to dig into the financials and find the best investments for your money!

In this video, I’ll show you the same process I used as a venture capital analyst to value startup investments. We’ll look at how to do a quick analysis of startup deals along with the warning signs to look for in each investment. I’ll show you how to look at the financial statements to find the investments with the most potential and how to value these high-return deals.

The video is in partnership with equity crowdfunding platform Republic, a platform that connects investors to these startup investment opportunities. Anyone can invest on Republic and you can get started for as little as $10 in some of these deals.

What I like about Republic is its VC-grade approach to due diligence and analysis. The platform has a team of analysts looking over potential deals, looking at prior financing, the business model, management and the market. In fact, less than 1% of the startups seeking funding get approved and make it in front of investors.

That due diligence by Republic is important and I’ll leave a link to Republic below but it doesn’t mean you’re off the hook for your own analysis. I shared the results of that angel investor survey in our prior video, a survey that found an average 27% annual return for investors. That’s a multiple of about 2.6-times your investment.

See how easy it is to get started investing in startup companies on Republic!

How to Get Higher Returns in Startup Investing

Look at this second graphic though, that same survey breaks out the investment returns by the amount of analysis or due diligence given to each deal. The median time spent analyzing each deal was around 20 hours, which isn’t too shabby. Now look at the difference in returns though. Investors that spent less time analyzing these deals, that’s the red bars, made just 1.1-times their money over the period. That’s barely getting your money back.

Does Due Diligence Matter in Startup Investing
Does Due Diligence Matter in Startup Investing

Now consider the returns for those angel investors spending more time in due diligence, including the 26% of the deals that involved 40 hours or more of analysis. Those investors reported a 5.9-times multiple on their money.

Nation, a 5.9-multiple on your money comes out to a 54% annualized return. A 50%+ annual return by taking a little more time to analyze your startup investments and using the exact process I’m going to share with you now.

So I want to get started but if you haven’t watched the first video in the series, make sure you check that out. It goes into detail on startup investing, equity crowdfunding and why every investor needs these in their portfolio.

What is Equity Crowdfunding Analysis?

Now you’ll hear me use the term due diligence and analysis pretty much interchangeably throughout the video. Due diligence is that process of analysis you use to weed out the bad investments and find the best deals for your money.

Because of that high failure rate on small businesses and startups, it is absolutely critical to using some kind of a due diligence process.

How to Analyze Startup Management

One of the first steps in this startup analysis is looking at the company’s management team.

I know angel investors that look almost exclusively at management, that’s how important it is because I don’t care if you have the best product in the world or a hot market, if the company’s founders and their team aren’t ready to take that company to the next level…it just isn’t going to happen.

Management and the founders have got to be hungry. They can’t be satisfied with good growth, that have to want to dominate that market and be willing to sacrifice everything else until they do it.

Now this one is a little more abstract than the other points we’ll look at so you really want to look at the company on four factors here.

What level of experience does management have in the industry?

This is huge in a world of easy startups and serial entrepreneurs. You get so many people out there that have never really worked in an industry. Maybe they have some tech experience and can create an app but they’ve got no real experience in the industry in which the app is competing. So for example here, if you had someone create an app for food delivery that had never worked in the food industry maybe in quick-service or delivery.

So if not the founders, I at least want to see some deep experience in the industry on the management team. I want to see that they’ve worked the different roles in the industry and have experience managing those roles.

I also want to see some experience in finance for someone on the management team.

Maybe this is just my bias as a finance guy but I want to know that someone on the team knows the numbers. Having that great idea and the passion is one thing but you better be able to understand how the financial side works out and be able to plan through it.

What Assumptions Do Startup Management Make?

Next, I’m going to take a close look at management’s market share assumptions.

I love this one because if nothing else, you can always get a good laugh when you find some of the bad investments. You get entrepreneurs that think their company is the best thing since sliced bread and is going to come into the market and just turn it on its head.

And I love the passion and the excitement but if your assumptions for how much of the market, how much of sales, you’re going to take from competitors isn’t realistic…it’s going to be a hard pass for me.

So here you’re looking for management’s assumption of the market size, how much in sales for that product is booked for all companies. Then you’re looking at what level of sales management thinks it can make over the next few years, what revenue it’s projecting.

Most startups aren’t going to be able to come into an established market and take more than about 10% of sales so be weary of management assuming they can dominate the market immediately.

How to Analyze Startup Competition

Finally on the management side, I want to see that the team has thought about the competition.

First, has management even researched the competition? The biggest red flag for these kinds of deals is a team that says, “There is no competition for our product.” That’s the point I just walk out of the presentation.

But besides that basic competitive research, I also want to see that management has thought about what competitors will do if this new company enters the market in a big way. Will they start a price war and how will management respond? Are competitors likely to raise legal challenges or spend more on marketing to retake market share? All questions management has to ask and answer before they’ll get my investment dollars.

The warning signs here of course would just be a total lack in some of these areas. So if nobody on the management team had any industry or financial experience. Or if management thought it was going to jump into the market, taking a huge share and never get any pushback from competitors.

Financial Analysis for Equity Crowdfunding

After doing this analysis on the management team, I move to the financials and projections for the company.

All startup investing deals will provide some level of financial reporting through Form C filed with the Securities & Exchange Commission and linked through the Republic platform. Clicking through to the form, you’ll see a balance sheet and income statement for the last two years.

Reading through the form, you should also be able to find some of the assumptions we talked about like market share and competition. If management doesn’t explicitly forecast sales or earnings, these can be used to make your own estimates for sales over the next two or three years.

Now what I’m looking for in these financials is, again the assumptions management is using going forward, and a comparison with companies already in the market.

Most deals are going to have publicly-traded companies already in the market, so companies with public stock and reported financials. You can go to the investor relations pages for these competitors, download their financial statements and use that as sort of a sanity-check for startup deals.

That means, you’re looking for the same assumptions by management at these established companies in the same industry. How fast do they expect the market to grow? Can you find any commentary on growth in costs or product prices? You want to compare what the startup management is saying against the reality of what you’re hearing from competitors.

Some warning signs here would be if management isn’t giving any kind of projection or forecasts for future sales or earnings, they aren’t even making an effort to estimate the numbers. Another warning sign would be if assumptions on growth or costs are way out of line with what you see in competitor reports for the market.

How to Value Startup Investments

The way you value startup investments is by comparison with publicly-traded companies.

Here’s the analysis I did on Pinterest years ago before it held its IPO, when it was still a private company raising money from angels and venture capital. You can see, I started by finding all the similar companies with public stock, so those in the social media space. Then I found the price-multiple on those shares for price-to-sales and price-to-monthly active users which is one of the most important measures for social media.

How to Value Equity Crowdfunding
How to Value Equity Crowdfunding

Looking at how much investors were willing to pay for sales and for each MAU on these other sites, I could use the sales projections and user estimate from the Pinterest deal to find a fair value for the company.

You can use this valuation along with your analysis on management and its financials, use this all together to get an idea of whether you should invest in the startup or not. Is the company’s valuation at which it’s raising money high compared to your own analysis? Do you see any of the warning signs in management or financials?

Asking yourself these questions doesn’t guarantee a good investment but it does raise the odds significantly that you’ll be investing in the best new companies.

Check out the Startup Investments Available NOW on Republic!

Nation, I know it’s a lot of work. This is what I did full-time as a venture capital analyst and it can seem overwhelming but this is how you find those investments with the potential to five- and 10X your money. I’ll be using two startup investment deals on Republic in our next video to show you step-by-step how to apply this process so make sure look for the link to Republic above.

Sharing is caring!

Speak Your Mind

*