Check List for Investments in Startups

Founding Team

When you ask professional venture capitalists what they pay attention to most when they invest, the most frequent answer is: the team. A fantastic team can lead an average product to success, but an average team can fail even with a fantastic product. Experts first check if the founders have the necessary experience in their field. Moreover, the founding team needs at least one person who has the necessary knowledge of economics and ideally also initial management experience. It is thus often considered an advantage when a team member is a “serial founder,” meaning someone who has already launched one or more organizations, even if these have failed.

Product

The core question before investing in a startup is: What is the product or service that the startup offers? As an investor, you want to be able to understand the product quickly. A couple of sentences should be able to explain what about it is new or what problem it solves for customers. A classic crowdfunding is usually appropriate for the development of a prototype; equity crowdfunding is intended for the growth of the company. Here, crowd investors might already be able to gauge the growth potential, for example through the expansion of the product’s functions. Questions concerning brand rights are also important: is the product patented or can it be easily copied?

Business Plan

The product or service alone is not conclusive. What is also important is how the startup plans to make proceeds from it. These don’t necessarily have to flow in the first years, but a clear business idea should be recognizable. Taking a look at the business plan helps in this regard. It contains a concept for the monetization of the business ideas. Only if the plan seems plausible is it worthwhile for crowd investors to participate. Scalability of the business ideas is also important. The question is: Can the startup win customers quickly and cost-effectively? This point is often a given for digital ideas, as new customers can be won internationally without much financial effort.

Unique Selling Proposition

Competition livens up the business, but it also eats up resources. Accordingly, companies strive to always be one step ahead of their competition. No customer needs the hundredth taxi or food delivery app if it doesn’t provide him or her with a decisive added value. So, what is the startup’s unique selling proposition that differentiates it from its competition? What secures its head start, even in the long run? Startup founder and venture capitalist Peter Thiel once said that a new technology must be 10 times ahead of its fiercest competition to attract interest. Thiel only invests if the startup has the potential to take over the lion's share of its market.

Market Potential

This leads us to the next point: The marked should be large enough to remain interesting in the long run. A niche product has a considerably harder time in the long term than a product made for a mass market. Naturally, this is also dependent on future trends, which are difficult to gauge in the present.  Thus the market for software products and services surrounding the topic of artificial intelligence (AI) is limited today because the technology is still young. But as it grows it will turn almost all sectors of the economy upside down, wherefore the market for potential customers is huge. If one believes the renowned economic advisors of McKinsey, already in ten years, 130 billion dollars will be made with AI products – every year. Another factor that plays an important role here is the target group. Has the startup correctly identified its target group? Is the group too broad or too narrow?

Financial Plan

Every investor should thoroughly look at the startup’s financial figures. The first question is whether or not the plan is realistic and feasible. Since startups generally do not make much revenue in the first few years but rather are busy investing in their business, they lack reliable output value. This makes the company valuation in terms of venture capital a challenge. Therefore, the startup should be able to explain clearly where future revenue will come from. One key figure that crowd investors should always keep an eye on is planned cash flow. It is the heart of an organization and is more useful to predict business development than are target revenue and profits. Economics professor Alfred Rappaport once said: “Cash flows are facts, profits are opinions.” In addition, crowd investors should pay attention to industry-specific key figures. For a mail-order company, for example, these are storage and transport costs in relation to turnover; for a hardware startup, perhaps these would be production and distribution costs.

Participation Rate

Experienced crowd investors pay close attention to the conditions at which the equity crowdfunding is offered. Next to the company valuation, the participation rate is of particular importance here. Both points are the result of extensive negotiations between the platform and the startup. Crowdfunding platforms such as Companisto always want to present the most attractive offer to crowd investors and therefore strive to achieve the lowest possible valuation. They also pay attention to the level of participation in the negotiations. The offered participation should be 5-30%. Because equity crowdfunding often involves early-stage financing, there is still room for later investors to enter the market. In other words, if the whole cake is distributed too early, nobody will end up with anything.

Network Effects

Next to the founding team, the startup’s network is also important. For example, are there experts in the council that can support the startup with know how? These include both researchers as well as mentors who pass on their valuable experiences in the areas of company formation and management. Furthermore, professional co-investors like business angels, investment funds, and venture capitalists are always a great plus. These usually conduct a thorough risk assessment, and although professional investors can make mistakes, their involvement often acts as a seal of trust. They also have extensive networks through which they can support the founders.

Allocation of Resources

A financing round at Companisto is considered successful if the sum collected exceeds 100,000 euro. As a rule, however, the startups generally set their financing requirements well above this level. Therefore, they are expected to explain how they intend to use the funds from equity crowdfunding. This explanation can also be very informative for crowd investors. Will the money be used mainly for marketing purposes? Or will production capacities be expanded for the time being? Should new markets be tapped with the money? Or are new employees to be hired? Depending on the business model, different points are important, but by demonstrating prioritization, experienced investors can already recognize whether the founders know what they are doing or whether they are acting blindly.

Taxation

When an investor has made an investment in a startup, his or her next question concerns the taxation of profits and losses from this investment. It depends on the country in which the investor pays taxes. In Germany, distributions from investments in startups are generally subject to capital gains tax of 25% and the solidarity surcharge of 5.5% on capital gains tax. There is no possibility for private individuals to deduct losses for tax purposes. In the case of an investment made via a limited liability company (GmbH or UG), however, losses can also be deducted for tax purposes. We have developed a special Tax Guide for Crowdfunding on Companisto for the tax treatment of equity crowdfunding.

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