The 5 “M”s of investing
There are a number of critical areas to assess when considering investing in a high-growth startup. In this insight article, we will cover five of the main areas to consider when carrying out an initial review of a potential startup investment opportunity.
A snapshot overview
3. Model (Business)
These are in no particular order (except that “management” always comes first).
An “A grade” team with a “B grade” idea can make it work. They can take a good idea and make it great. How? Through having the right combination of skill sets, knowledge, drive, passion, and just plain, old-fashioned hard work, grit, and determination.
However, a “B grade” team with an “A grade” idea just won’t work. An idea, no matter how great it is, just won’t become a viable and successful business venture without the right people behind it. The team is key.
The calibre of a team is usually dependent on what stage of growth a business is at. For example, a business looking to raise funding in a Proof of Concept (POC) round probably won’t have more than one person on their “team”, as it is one of the first stages of growth; in fact, at that stage, the business can even be considered pre-growth.
However, a more established team, who have been operational for more than 2 years, will have built up a credible team: both internally and externally. All skill sets should be covered as quickly and effectively as possible.
As part of the work we do with entrepreneurs who come to list on the GCV Invest platform, we help them to understand the necessity of building a strong team. From highlighting potential gaps in skillsets and team members to considering the most appropriate choices for board members and advisors.
As well as this, we ask how and when these gaps can be filled either with the budget the business has currently, or following a successful funding round. Investors want to know how the investment will be used in terms of building the best team possible. They want to know that their investment will be put towards giving the business the best chance of succeeding.
Looking at a team from your perspective, as a potential investor, how strong a sense of entrepreneurial spirit do you get? If that often indescribable “vision” or creative spark is missing, it may or may not be a warning sign that the entrepreneur doesn’t have the ability to execute the plan and make the business a success. You need to select investment opportunities that give you confidence in the business owners’ ability and drive to succeed.
Before investing in a high-growth startup business, you need to look at a number of things, including the sector they operate in and its competition. This should give you a better understanding of how the business could perform in current climates, as well as the market demand for such a business. If there is a large demand, then the business has more high-growth potential.
There are two types of investment strategy: Top-Down and Bottom-Up. Both approaches are ways of investigating the marketplace in order to determine where investments should be made. Which approach do you use?
This is where the investor looks at everything, including GDP, exchange and interest rates, and inflation. From this, sector, sales, and competitor analyses are carried out, which gives the investor a clearer understanding of which industries are likely to outperform others in the near future.
After narrowing the field down to specific sectors, in this manner, the investor is then able to identify the most promising prospects and then look more closely into individual businesses.
As the name suggests, is the opposite approach to Top-Down. Whereas Top-Down starts with considering macroeconomic factors, Bottom-Up ignores these completely and focuses instead on the qualities of individual businesses. This approach relies on the personal choice of the investor, who often believes that an individual business can thrive, regardless of outside factors and the performance of similar businesses at that time.
Both approaches offer benefits in choosing where to invest, but since no one can accurately predict the future, there is no surefire way to choose the “right” business. Investing in startups is a higher risk/higher return investment strategy and as such, an investment portfolio should be diverse in order to mitigate the associated risk. Therefore, it is up to you as the investor, to decide which investment strategy you are most comfortable using. That way, you have more chance of becoming an “expert” at looking for warning signs, good or bad, as well as growing confidence in choosing businesses with high-growth potential for your investment portfolio.
Whichever approach you use, make sure you learn everything you can about the size of the relevant market, as well as the current market trend; is it growing, in a bubble, or the next big thing? A bubble refers to a “boom” period which is then followed by a “crash” or “bubble burst” and is, therefore, usually only conclusively identified, retrospectively.
Let’s take a look at the Fintech sector; this is the sector that GCV Invest operates in. Fintech is an exciting marketplace and currently has a lot of buzz going on around it. In an article written for Forbes, David Prosser writes that “fintech investment in UK venture is now growing more quickly that in any other market in the world”. Click here to read the full article.
A business model is an outline of how startups intend to acquire, service and retain customers. It is often condensed down from the company’s business plan and can give you, the investor, an indication of how the entrepreneur will establish and grow their business. Some examples of business models are franchises, advertising, subscription, and direct sales.
The business model of the investee company needs to show that it is innovative or disruptive. If not, then it probably doesn’t have anything special to offer, no unique selling point (USP), setting them apart from existing competition. Although no one can predict the future, this would seem to indicate that there is no growth in the business; other people are already occupying the exact space, offering the same thing, and have history and gravitas behind them.
So what evidence exists that you can use, in order to see that a start-up or early stage business has put thought into its business model? Well, a couple of indicators come in the form of the Business Model Canvas and the Lean Canvas. Let’s take a look:
Business Model Canvas
Originally created by Alex Osterwalder, the business model canvas is a one-page document which many entrepreneurs use when planning the strategy of their business. Writing for Forbes, Ted Greenwald, refers to the business model canvas as a “simple graphical template”.
The Lean Canvas was conceived by Ash Maurya - @AshMaurya as a response to the Business Model Canvas that he dismissed as being “too simple”.
How does the business/investment opportunity intend to monetise? Below is a list of some of the most popular revenue models. Obviously, businesses with recurring revenues are often the most attractive prospects because they show more potential for a steady turnover.
- Retail and e-tail (off and online commerce)
Momentum is where you check out the customer interest surrounding the investee company and sector. If it sounds like it’s linked quite closely to the research you will have undertaken in the market, that’s because it is. It’s worth asking yourself whether or not you believe that the business solves a genuine problem in the marketplace.
If the answer is yes, then that’s a good start. Then you need to see how many people need that genuine problem-solving; this will indicate either actual or potential customer interest. Look at the traction the investee company has in the marketplace.
Does the business idea resonate with a lot of people? Does it resonate with you? Do you believe in the business model, the revenue model, the sector, the potential to succeed, and the team?
...that’s right, we’re back to the start: the team. Are they that “A grade” team, and do they have the momentum to build their business and take it to a successful exit?
If all the evidence indicates that the answer is “yes”, as well as your due diligence, and your gut instinct, then you may have identified an investment opportunity that could form part of a well-diversified investment portfolio.