Sometimes it’s good to go back to basics. And one of the basics that every investor has to consider before making a startup investment is upside — does this startup have the right pieces put together to provide significant upside on my investment?
That question often isn’t easy to answer. There are a lot of factors that decide whether a company succeeds or fails. But in that mix of factors, there are a few characteristics that every investor should keep an eye out for. These are three simple things I look for when evaluating a startup’s upside potential.
- Mega-disruption. This one sounds like it should be obvious… Solutions that address huge global needs and achieve wide-scale adoption definitely provide upside. But often, this ability for disruption is only obvious in retrospect. When I first used Alibaba 20 years ago (looking for green construction glass from Vietnam), hardly anyone in this country had even heard of Alibaba. Even when I used it, I didn’t think, “My gosh, this company is destined to become a $700 billion company.” That would have sounded silly back then. And that’s because mega-disruptions upend accepted paradigms. They seem unrealistic or too far-fetched before they happen. (Think psychedelic drugs today. They will transform how we treat and maintain healthy minds.) Mega-disruption can be hard to discern in the here and now. But keeping an open mind and developing the ability to see disruption before it happens is an extremely valuable skill for startup investors like you and me.
- Getting to the next round. With that said, don’t forget the other end of the spectrum. What good is long-term potential if a company can’t hit the milestones that enable another raise before it totally runs out of money? Companies off to slow starts — still in their prototype, pre-production or beta phases — are particularly at risk. That’s not to say these startups are always bad investments. They just require a little closer inspection. What is their 12-to-18 month plan? Are their goals realistic? And will it be enough to incentivize investors to write them checks? Reducing funding risk and nailing short-term progress are critical requirements for a startup to have upside potential.
- Government-driven opportunities. This is one of my favorite drivers of upside — and an underrated one too. Government regulations move markets. When a new rule allows a product or activity that was previously prohibited — or when they ban or prohibit something previously allowed — entirely new market opportunities are created. Consider this: Toxic mercury bulbs may be eliminated soon (by the Minamata Convention), opening up huge market opportunities for alternate products. That’s just one example of regulation driving market shifts. There are also the cases where a startup steps in when the government has failed to plug a need or solve a big problem. Government-driven opportunities can provide a rare level of stability to a startup’s prospects — which is great for investors and for upside.
I’ll be providing more easily digestible tips like these in the coming weeks. In the meantime, hopefully these three indicators will help you evaluate upside in startups — and better enable you to decide whether a company is worthy of your investment or not.