You decided to invest in a startup, but there are many terms involved... what is important to know before start investing?

As everything else, startups and angel investing have their own jargon. Runaway, term sheets, safe notes, due diligence... and many other terms you are not used to. You want to join that syndicate (ops, another term) or investment group your friend recommended, but don't want to play without knowing the rules of the game. What is important to know before start investing?

What is important to know before start investing

1. The team. Do you think they have the skills needed? Do they have enthusiasm, resilience and drive to succeed? Execution is the name of the game. Some investors only invest in serial founders, or founders with previous successful exits. It means those people were capable to develop the business, despite all the challenges involved. It is a good start point, but those founders were also first time founders before, so it does not mean first timers have less chance to be successful. The startup team play a big role too. Some teams work better together than others. See if the team have the required capabilities. I recently saw a pitch of a startup which product was AI based, but the only tech person was an intern. Another red flag, founders that totally delegate the commercial side to a newly hired employee. Selling is the heart of your business. If you can't sell, you don't grow, and the business will probably fail.

   
   

2. The opportunity. What is the startup business model? Is it a new type of product, service, or is it a new way to address the market (ex. SaaS)? Do they leverage technology to do that in a cost competitive way?

   
   

   When someone say they have product market fit, it means customers are willing to pay for their product. Which brings us to the next question, of how much sales and revenues are growing through time, which means that they also have traction. The proportion of recurrent revenues (ARR annually, or MRR monthly) is important to evaluate the level of effort needed to grow by acquiring new clients vs leveraging existing ones.

   
   

   The market size is another important aspect, as investors need the Company to grow substantially to be able to realize returns. Of the total available market (TAM), how much they can address with the proposed solution (SAM-serviceable available market) and how much is it feasible to get with the resources they have (obtainable market)? What about competition? What makes that startup special compared to other players?

   
   

3. Deal terms. The deal has a price, which is defined by the amount of shares, or % of equity, you get for your investment. It depends on the value founders are assigning to the Company (valuation). Valuation is usually based on multiples that depend on the amount of revenues and its growth rate per year. Valuation is a tricky topic for initial Companies with not many revenues, so it might be interesting to take a look at other deals of similar startups or of startups in the same industry.

   
   

   In case you get a promise to convert the investment in equity in the future, you need to see what would be the maximum valuation (valuation cap) and discount used for conversion. And that brings us to the cap table, which is basically the list of current shareholders and their participations. An important aspect here is to understand how many shares the founders own and if they will have enough shares in subsequent rounds. If they get too diluted early on, they will end up retaining a small portion and having less incentive to further develop the business.

   
   

   Not less important is to understand how the startup plan to spend the funds raised? What they expect to achieve (milestones)? Are funds enough to make the business grow until the next investment round, or is there a risk to run out of funds before it (startup runaway is the amount of months they can continue operating without new funds)? I recently saw a pitch where revenues were based on developing a new product with a strong tech component, but out of the total funds raised, only 5% would be used for product development and another 5% for technology.

   
   

4. Exit potential. We all invest inspired by the unicorns people talk about, but the reality is that most exits are in the form of acquisitions. Ask questions about it? Who could

This is a brief summary with the concepts that cover the basic areas you need to be aware of. Investing can get much more complicated than that, but it is a start point. In Angel Investing Explained, you can find more details. I would also recommend you to do some additional research and get more familiar with the topics. Investing, as an activity, will teach you a lot too. From this initial list, you can elaborate a few questions to be able to understand the main aspects of the investment and see if you feel confident about it.