Before investing in a startup, investors will first conduct a thorough analysis and due diligence on the business. Investors’ approach to this process differs depending on their investment motives.

Financial investors such as angel investors and VCs invest for financial gains whereas strategic investors such as corporations invest for other strategic benefits.

We explore what goes on in an investor’s mind before he or she decides to write the cheque.

While what is discussed here would be more relevant for the financial investor, the strategic investor will have many of these in their evaluation toolkit as well.

The product, the market and the team

With pre-seed to seed stage startups, we assess whether there is validation of the pain point the startup is trying to solve. We look at evidence that the pain point exists and see if the solution is a ‘must-have’ or merely a ‘nice-to-have’. This can be determined from analysing user growth, feedback, customer interviews as well as user engagement levels.

For seed stage to post-seed-stage startups, we focus on whether product–market fit has been achieved, i.e evidence of a market worth serving. Studying the evidence of traction, we analyse whether it is driven by early adopters or a broader market. We would also like to see how high the pain point ranks as a priority among customers in the broader market.

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By investigating the market the startup is in, we evaluate whether there is an opportunity to build exponential growth in a market that is sizeable and robust. We gauge whether market conditions enable the company to build value much faster than it is incurring the expenditure.

We compare the product against the competition and determine if there are distinguishing factors that matter to the customer. To disrupt a market, the product should be perceived to be multiple times better, cheaper or more efficient than the incumbent solution.

After understanding the market the startup is in, investors would analyse the go-to-market strategy. What we’re looking for is a plan and business model that allows the company to acquire customers cost-effectively. This is influenced by the channels relied on for customer acquisition. We compare the costs of acquiring customers against the future revenue they bring in. This sheds light on how scalable the business is.

In a tech startup, we need to find out how the current software would cope if there is a multifold increase in customer traffic. Is it a question of adding additional equipment with no material changes to the framework or would the software need to be rewritten? This can impact on scalability.

For tech startups, there needs to be a plan and procedure for product management. Markets and customer requirements constantly change thus companies need strong product management to accommodate such changes speedily.

Whether the startup has in-house technical resources rather than outsourced ones will be key to its adaptability and profitability.

Also Read: How e27 Pro helps startups remain in view of APAC key investors

We need to understand the skillset and experience of the founders – their strengths and weaknesses. We find out why this particular founder has chosen this particular business, how committed is the founder and what are the chances of the founder persisting with the business and succeeding (as explained in Angel by Jason Calacanis).

Also, the founding team should ideally be equipped with a combination of selling, technical, and product management skills.

Growth plans and projections

An important part of a startup’s investment case would be its growth plans and projections. This includes the user growth required to achieve its growth targets given the user engagement, customer acquisition and retention. In addition, we also focus on the revenue growth required given factors like customer lifetime value, pricing, product mix, etc.

With projections, investors would study the critical assumptions carefully especially those relating to growth, margins, and capital expenditure. The current financing round needs to help the company hit the benchmarks for the next round of financing.

Next, we evaluate how the growth plans and projections relate to the future valuation of the business. We analyse the basis and value drivers behind the valuation.

Estimating an exit valuation, we assess whether the investment returns make sense given the entry valuation.

Also Read: Qualgro Partners: Southeast Asia is home to the next big B2B tech companies

Further due diligence and deal structure

Due diligence on a startup will not be complete if investors are not mindful of the regulatory environment and its impact on the business. We should see if all relevant approvals and licences have been obtained and the conditions attaching to them.

Also, it is useful to know if regulatory requirements provide any form of barriers to entry against future entrants.

Together with legal advice, we determine if the technology or solution is capable of having intellectual property (IP) protection. This goes towards building a moat against competitors. We should also find out if any aspects of the business are infringing on the IP rights of others.

Additionally, check whether current and past employees have assigned to the company all IP rights for work they have done.

Investors would also analyse the structure of the investment including the financial instrument to be invested in, be it equity, convertible, SAFE note, etc. and its terms. The idea is to have the terms provide downside protection for the investor, good governance as well as an efficient exit for profit realisation.

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