How To Evaluate A Startup Investment

Angel investors don’t become successful through luck. The pros know where to find the deals. 

But equally important, they know which are worth pulling the trigger on and when to walk away.

The single most important skill every angel investor needs — the ability to evaluate an opportunity.

I’m going to break down some basic considerations. 

While this is a good starting point each investor should come up with their own evaluation process that fits their needs and situation.


First Impressions

Your prospective startup will have some information for you to check out. These documents or presentations will give you a run-down of the company’s ideas and goals and try to hook you in.

We’re talking about term sheets and pitch decks.

This is your startup’s first chance to wow you. If they don’t put their best foot forward or something feels wrong at this stage, don’t be afraid to ditch the opportunity right then and there.

Here is what you need to look for in term sheets and pitch decks, and what you need to know.

Term Sheets

A term sheet is an outline of all the terms of investment. This document is just an agreement — it isn’t legally binding. Legal documents will be drawn up later and will be based on the terms in the term sheet.

The startup and investor(s) can sometimes negotiate the terms of the document. Other times (ie. when investing in a startup through a Regulation Crowdfunding campaign) the terms are set.

Some of these terms are:

  • The startup’s investment goal
  • The company’s current valuation
  • Ownership percentage and price per share
  • The type of security offered (common stock, preferred stock, SAFE notes, etc.)
  • Voting rights
  • Dividends
  • Liquidation preference

These documents should be professional, and the terms should be reasonable and comparable to their competition. If you’re unsure, try to find out what other similar startups are asking for.

Pitch Decks

In a different setting, you may attend a pitch deck to decide if a startup is worth investing in. This is an investor presentation — sort of like what you see on Shark Tank.

The startup founders will give a short pitch to show their idea, potential market, and business plan. Along with the pitch, the founders will give you other documents that you should study over to get a good look at the company.

During a pitch deck, watch for the startup’s:

  • Team
  • Product or service
  • Business model
  • Finances
  • Market size
  • Competition

A good investment opportunity should be able to touch on all these points and make a convincing case for their business. 

Salesmanship isn’t everything, but a strong founder (a jockey) that can push the idea and get you excited is a good sign.


The Most Essential Components of a Startup

There are 2 main things to consider when evaluating an investment opportunity. If either of these seems wrong to you — don’t get involved.

The Team

When you’re investing in startups, you’re really investing in teams. An incredible idea isn’t all that it takes. A startup’s ideas, business plan, or valuation mean next to nothing compared to the team.

How long have they worked together? Have they had success in the startup world? How have they overcome obstacles so far?

Knowing — or not knowing — your team is the number one factor that can make or break your investment.

To lower your risk, always look for outstanding leadership in the company. Leaders with track-records of bringing startups from inception to profitable liquidation are your best bet.

Keep in mind, if a startup has A-list business people at the helm, they will charge a premium on their valuation.

Less experienced teams will run you more of a risk. If you have a great eye for people, you can find a rookie team that will succeed. Look for team leaders that have outstanding knowledge of their business.

Try to find their work history — where did they come from and what’s their work ethic like? 

Low-experience, high-risk teams can be a benefit to you in terms of a startups valuation at the time of your investment.

The Values

Consider the founder’s values and ideas. Is this a project you believe in, care about, and stand behind? If you don’t see eye-to-eye with what the founders are doing and don’t get excited about the idea — don’t hop on board.

I get it — you might have dollar signs for eyes and you don’t care about values right now.

Trust me, you may be sticking with this company for a long time. The pot o’ gold at the end of the rainbow is a long way away. Liquidation probably won’t happen for 4 to 7 years…maybe even longer. 

Do you really want to spend years following a startup that you don’t even like?

Pick something you believe in and you’ll be happier and more confident in your investment.


Deciding Your Investment Goals

The next part of assessing a startup comes down to your needs as an investor. We all have different goals, tolerances, and availability. Make sure yours align with the startup’s roadmap.

Your Level of Involvement

Do you want to be active in this thing, carrying the torch? Or do you want to watch from the sidelines? There’s room for both in the angel investing world.

Many companies could use your expertise. If you are buying equity, you are essentially a part of the team. You can take part in decision-making, which can yield great results for everyone.

On the other hand, investors who go through a venture capital firm will not have the same potential of involvement. Or, if you invest through a crowdfunding platform, you can buy equity, but likely won’t be so involved.

Timeframe and Exit Strategy

Next up — how long are you willing to wait and how will you get out?

Angel investing is a long-term game. Most investments will take years to play out. Some investor’s portfolios have no trouble waiting 10 or more years for a return, whereas others may need results within 5.

When will you be able to sell your equity? When do you need the money? How does this fit into your portfolio? Ask yourself these questions and make sure you’re ready to play the waiting game.

Studying the startup’s plan can help you to map out a timeline that works for you. Assessing the burn rate, or how much money the company spends each month, can give you some clues. 

If in the early stages a startup has an incredibly high burn rate, you might not be getting your money back any time soon.

And in more uncertain times, you’ll want to understand a startup’s strategy to keep their burn to a minimum.

Evaluating Risk

We can’t discuss evaluating a startup without talking about risk. Investing in early-stage companies, many of which have little or no track record, comes with a fair amount of risk.

Here are examples of a few risk factors that can affect investments in startups:

  • Economic – downturns in the domestic or international economy
  • Market – new competition, changes in buyer habits
  • Regulatory – government approvals and testing
  • Team – issues within the founding team
  • Financial – running out of capital or issues with future rounds of funding


Finally, the good stuff — your potential payday. I’m talking about return on investment (ROI). 

Before going into an investment, you need to know about your return. Know how you will get it, when, and how much. For anyone making multiple angel investments or managing a portfolio of investments, this is essential.

The truth is, most investments just won’t pan out. A good strategy is to do some quick math and see if your potential reward on one startup can cover the cost of multiple investments.

For example, if you make 10 angel investments, make sure that just 1 startup success can cover the expenses of all of them. You aren’t getting an ROI if you profit a little bit on one startup but lost money overall from your other angel investments.

You should keep track of your actual investment amounts and factor in any fees or costs you paid to take part.

Make an intelligent ROI plan that will cover your losses and expenses. You need to do the math — there’s just no getting around it.


Key Takeaways

With everything you just learned, you can start making more educated investment decisions and hopefully, building your wealth.

Find yourself an idea that excites you with a good team behind it. Study the offer, hear the pitch, and research until you’re totally confident.

From there, the only thing to do is make sure the opportunity vibes with you.

If you’re comfortable with the terms and everything fits together in your portfolio and with your life — you may have found an opportunity worth investing in.