By Omoruyi Edoigiawerie, Esq
Investing in a start-up can be risky, but it is also a potentially rewarding venture if it is done right, an exciting and possibly lucrative opportunity if engaged properly with the right perspectives in place. It is important to invest with wisdom and foresight, doing all you can do to prevent being blindsided by the lucrative potential of the start-up.
So, what is the formula? well, it is not far-fetched, before investing in any start-up, it is vital to conduct a thorough review and investigation to ensure that you are making an informed decision; this process is called due diligence which refers to the process of conducting a comprehensive review of a start-up’s business and financial operations, legal framework, market potential, and other key factors that can impact its success or lead to its failure.
A Due diligence procedure is a critical step in making informed investment decisions and reducing the risks associated with start-up investments. In this article, I will highlight the key considerations that investors should keep in mind when conducting due diligence on startups that they wish to invest in.
From professional experience and deploying a practical approach, below are some important considerations:
1. Evaluating the Founders and Management team
One of the most important aspects to consider when investing in a startup is the quality of the management team. The success of any company largely depends on the people who are running it, so it’s crucial to evaluate their experience, track record, and qualifications.
It is important to evaluate the founders and their management team by asking some critical questions which include:
•Their industry experiences
•Company/Business managerial experience
•Whether they have an articulate vision for the company’s future
•Any conflict of interest which may include personal financial problems or previous employment problems
2. Analysing the Market Opportunity
This is a very vital consideration when evaluating a start-up for investment. Investors must understand the potential market opportunity for the business or product. They can achieve this by evaluating the size and growth potential of the target market, as well as any potential competitors.
To properly evaluate the size of the market opportunity, the target customer segment, and the competition, it is important to consider the following questions:
•Is the market large enough to support the start-up’s growth plans?
•Is the start-up entering a crowded market with established competitors?
•Does the start-up have a unique value proposition that sets it apart from competitors?
•What are the regulatory or legal issues that may impact the start-up’s ability to enter or operate within the market?
3. Understanding the Financials
Money is the lifeblood of any business, and it is impossible to even position the start-up to attract investment without money, therefore investors should also evaluate the financial health of the start-up before making any investment decisions. This includes reviewing the company’s revenue, expenses, and cash flow.
Some questions to ask when evaluating the financials include:
•How much revenue has the start-up generated thus far?
•The start-up’s projected revenues and expenses over the next few years?
•Does the start-up have a clear plan for generating revenue and becoming profitable?
In addition to the above questions, it is very important to review the start-up’s cash flow to determine if it has enough capital to support its growth plans and cover any potential setbacks or unexpected expenses.
4. Legal and regulatory compliance
It is unimpeachably important for investors to understand the legal structure and regulatory framework within which the startups they seek to invest in operate. This will help clearly understand if the start-up is compliant with all relevant laws and regulations, and even more importantly, if it has all necessary licenses and permits.
Investors should also review any legal or regulatory issues that may impact the start-up’s operations. This includes reviewing the company’s compliance with regulations, as well as any pending lawsuits or legal disputes. Investors should also assess the company’s labour/employee policies, risk management procedures, corporate governance framework, and management policies and procedures to determine if it has adequate measures in place to mitigate the risks and ensure legal and regulatory ease.
5. Intellectual property Portfolio
One very important aspect of a start-up’s market presence is its brand, you cannot talk about a brand name without reference to Intellectual Property, understanding the status of a Startups Intellectual Property (IP) Portfolio will ensure that the product or service’s brand presence is not only protected but that there are also concrete measures in place to ward off unnecessary market proliferation capable of adversely affecting the start-up’s growth. It is therefore important to evaluate the start-up’s IP portfolio whether it is patents, trademarks, copyrights, or even trade secrets.
To address this concern, it will help to ask founders the following questions:
• Does the start-up have any existing Intellectual property registration?
• How valuable is the start-up’s IP portfolio?
• Is the start-up’s IP relevant to its target market and does it provide a competitive advantage?
6. Ensuring an Exit Strategy
The end of a thing is just as important as the beginning, that’s even if it is not even more important. Investors should consider a workable exit strategy before making any investment decisions. There must be a plan in place showing how they will eventually sell their stake in the startup and get a return on their investment.
It is imperative to consider the following questions when carving out an exit strategy.
•Does the start-up have a clear plan for exiting, such as an IPO or acquisition?
•How long does the start-up expect to remain private before exiting?
•What is the potential return on investment?
As I said at the beginning of this article, investing in a start-up can be a high-risk but also a high-reward opportunity. Therefore, conducting due diligence is a critical part of investing in a start-up. By considering the above areas, investors can make an informed decision about whether to invest in the company. While due diligence can be time-consuming and costly, it is a necessary step to mitigate risk and increase the chances of a successful investment. By taking the time to thoroughly evaluate the factors raised above, investors can make informed investment decisions and increase their chances of success