The second pitfall is a decline or change in quality of service/experience. Many businesses – whether it is an artisan coffee shop or a software product – win custom because of the people and the experience they deliver. When a company expands too quickly, scale stampedes the culture that made the business successful in the first point and the customers go elsewhere.
A preventative cure for the ails of rapid expansion is experience. So, if the founding team are green in this area, make sure they bring in the expertise they need – whether that is another friendly shareholder or an external consultant.
3. Get a fair price to get a return
Valuation is the price tag an entrepreneur puts on their business, and it is one of the trickiest things to assess in early stage investing. Business valuations can be a bit like house prices, art or antiques – the cost is however much the market, that is investors, will bear.
A valuation can be arrived at using a number of methods; from a bottom-up analysis to discounted cash flow analysis, to the still-too-common finger-in-the-air approach. There is no right way and the challenge for investors is deciding if the share price at which they buy in gives a reasonable chance of making a reasonable return. And importantly, that the price is commensurate with the risk. The earlier you invest, the greater the risk.
To assess this, it pays to understand the sector intimately. How does the valuation compare to similar companies in terms of stage, sector and assets (both IP and previous investments) that have recently raised equity capital? And what are typical multiples for businesses of that type at the point of exit?
4. Check the people
If you ask a room full of experienced angels what is the most important factor in an investment decision, they will unanimously shout, 'The people'. In fact, most would rather invest in a weak business idea with a strong team than a knock-your-socks-off idea with a weak team.
Experienced investors will look for sector experience, a well-rounded team in terms of subject-matter expertise and functional knowledge and last but certainly not least: trustworthiness.
Even if you find a great opportunity with a seemingly perfect team, you have got to do your homework. Many an investor has succumbed to the charm of an entrepreneur only to find out they were not all they were cracked up to be.
Ensure the directors hold the stated qualifications and verify their current employment status. You will also want to investigate if there are any previous insolvency proceedings or county court judgements.
