Weekly Update

A 10-Point System for Grading Startups

A 10-Point System for Grading Startups

A few weeks ago, Andy and I were discussing the First Stage Investor portfolio. I was intrigued by the different valuations across our holdings.

But Andy told me valuation is just one part of the picture.

To show me, he put together a list of 10 key traits to look for in startups. It was such a great summary that I squeezed it into our April issue.

Unfortunately, we didn’t have space to fit the more fleshed-out version of the list, so in anticipation of the issue, here they are:

  1. Fair valuation. Price matters. Determining fair valuation isn’t easy (or easy to explain). Our favorite method is the “market approach.” Fair valuation is whatever a buyer would pay for the company. And what a buyer would pay depends on the “comparables” (much like when buying or selling a house).
  2. Outstanding leadership. The founders and C-suites can’t just be good, they have to be great – great at building outstanding products and companies, great at executing their vision, great at overcoming problems. They also must have deep and sometimes dumbfounding knowledge of their sector. Prior startup success is preferred but not a must. It’s amazing how many founders succeed at their first go-around.
  3. Market size and growth. Big markets are nice, but not if they’re not ripe for disruption… or if customers don’t have obvious frustrations… or if the market’s not growing… or if the company addresses just a small fraction of the overall addressable market.We like companies that show how their market is pulling sales (as opposed to the company pushing sales). It’s a great sign that killer traction might not be far off.
  4. Monetization. Great products don’t always win the market. Great monetization strategies are just as important (if not more). We want to know exactly how the company is planning on making money. Price points, customer acquisition costs, margins and churn will help you determine if its product rollout plans are doable or just fantasy.
  5. A well-known investor’s backing. It’s definitely a positive and nice to see. But if it doesn’t happen? It’s not a big negative. Professional investors miss a lot of great opportunities.When there’s a lead investor, make sure they’re participating in the current round. If they participated in a previous round but aren’t involved in the current one, it’s a possible negative signal.
  6. A quality product. Use the product whenever possible. Do you like it? If not, don’t invest.
  7. A focus on future trends, industries and markets. Remember, startups take years to grow into (hopefully) dominant companies. How hot will their market be in five years compared with today’s?The blockchain is just getting started. It’s a technology whose impact will be felt in the future, not in the present. It’s why we like it so much. Try catching technology and user trends before they become obvious or highly visible.
  8. A polished online presence. Make sure the company you’re investing in has a respectable presence on the web. Check out its website, social media and any videos you can find on YouTube.
  9. Customer feedback. Look not only for positive feedback but for the “OH MY GOD, this is better than I could ever have imagined” variety. For software-as-a-service companies, look for small net churn (how many people are signing up versus dropping out).For consumer product companies, look for a low rate of return. And if you feel like going the extra mile, call the company’s retailers or distributors and ask them how much the customers like the product.
  10. The “why didn’t I think of that” idea. This is partly a reminder to trust your gut. But it’s also a recognition of the power of an idea whose time has come and, once it’s introduced, there’s no going back. Ride-sharing was one such idea. The taxi industry would never be the same again… ANYWHERE.In our own portfolio, we believe Court Innovations fits the bill. It settles minor civil court cases online. And it’s spreading. In a couple of years, people will remember the days of going to a brick-and-mortar court as an unbelievable inconvenience.

If you’re new to the startup investing world, deciding where to put your money can be difficult. With so many eager young companies looking for backers, sometimes investors get swept up in shaky startups. That’s why having a system for identifying those investments most likely to make you large profits is essential.

So if you’re feeling overwhelmed by the startup investing space, just know that you can take steps to limit your risk and figure out a plan.

Once you nail down an evaluation system for your investments, you’re well on your way to building a successful portfolio.

Invest early and well,

Allison Brickell

Managing Editor, First Stage Investor

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