Due diligence is a crucial part of making any investment. Most people wouldn’t buy a house without seeing the property, the area, the relevant documents etc. So why would you invest in a business without knowing what you’re investing into?
Investing in startups is inherently risky. By their nature, startups are doing innovative things, working in new areas or disrupting existing markets, making the chance of failure very high, putting investor capital at considerable risk. Investors can better understand the level of risk they’re taking on, and perhaps even mitigate a little, by conducting their own due diligence before making an investment into a company.
When deciding what investments to make, investors may want to consider the following factors:
- Define your investment criteria
Defining your investment criteria is often a good place to start. Different investments have different levels of risk – investing in a family and friend’s round for a super-niche consumer product is very different from buying a public share in Apple, as an extreme example.
Investors could begin by clearly outlining investment objectives, risk tolerance, sector preferences, and expected returns. This helps form a framework on which investors evaluate each investment opportunity based on their specific requirements.
- Review the business plan and financials
Every business should have a clear business plan. We require every business raising on Seedrs to have a campaign page where they’ll set this out in both the video and the campaign text. Is this something that you as an investor believe in? Do you see the potential for growth and success?
Financial performance to date is crucial. Unaudited financials can typically be found in a business’ pitch deck (available on request from the campaign page), and any UK business is required by law to submit their accounts to Companies House. You can navigate straight to a business’ Companies House records by clicking on the ‘Company Number’ on the campaign page.
Each campaign page will feature the ‘pre-money valuation’. This is the valuation of the business that the fundraise is based on, before the funds being raised are added (this is the post-money valuation). ‘Valuation multiple’ is an industry term given to the calculation of valuation divided by current revenues, so a business that generates £100k in revenue and is valued at £1m has a 10x multiple. Different industries and macroeconomic factors dictate different valuation multiples, but this is typically a good place to start with understanding if a business’ valuation is reasonable and in line with public and private comparable businesses.
Always be sure to take a look at the ‘Key Information’ tab on the business’ campaign page. Here companies disclose any outstanding debt or shareholder technicalities that may impact your decision to invest.
- Review the team
A business’ management team will be in charge of investing the funds raised and growing the business, hopefully to a point of exit. It’s always good to research members of the leadership team to understand their background and determine if you feel confident in their ability to grow the business successfully.
When it comes to ideal individuals to build and exit businesses there’s no one type who achieves over others. We’ve seen first time founders have as much success, if not more, than founders with exits under their belts. Review their backgrounds, the strengths and weaknesses of the team, and decide if you feel comfortable to back that group of individuals.
- Assess the market and competition
Some businesses will have an innovative idea that starts a market of its own, others will be disrupting multi-billion dollar industries. Whilst one will have ‘multi-billion dollar market opportunity’ on their campaign page, and the other may only have rough estimates of the market size, one is not necessarily better than the other. Businesses that create their own market category can succeed over and above those that are disrupting how something has always been done.
Take a look at what other businesses are out there doing the same thing in the same space, understand if you believe the business you’re investing in is likely to be the best in the market, and make your investment decision.
- Assess the technology and intellectual property
If the business is technology driven, it’s worth assessing the quality and uniqueness of the technology used, and how defensible it is. If there’s a big competitor in the market who could come along tomorrow and recreate the technology, that may be a red flag to an investor. If what the business is doing is highly defensible and hard to do without their unique skills and understanding, this can be a useful factor when it comes to exiting the business.
Intellectual property is key here. Patented technology is the ultimate layer of defensibility for a technology startup, so check what patents a business has, if any, and the quality of these.
- Scalability and growth potential
Startups may be working with a basic version of a product whilst building more, or working in one geography. It’s worth exploring whether the business model is viable in other geographies, or if a technology can be applied to different industries. The greater a business’ ability to scale and grow, the greater the potential market size, and the higher a valuation is likely to be able to go for an investor exit.
- Exit strategy
Startup investors invest on the premise that the private company will eventually exit, either by going public, being bought by another business, or merging with a competitor, resulting in all shares being sold.
Businesses will typically have an exit strategy in mind when raising capital, and it’s worth exploring whether you believe the business has the potential to achieve an exit.
Unanswered questions? Ask the founder directly
A lot of the information above should be available to you on the business’ campaign page but if there is any information you want more clarity on, you can ask the founder directly. We created the discussion forums because we think it’s vital that our investors can speak to founders directly, so that they feel there is nothing to hide and can be more confident when investing. Ask the founders anything you like, or take a look at what other investors have asked to help you make your investment decision.
What due diligence does Seedrs do?
When you invest on Seedrs, we’re not asking you to do all the heavy lifting. Investor protection is a core pillar of the Seedrs mission and we conduct our own due diligence on every business that chooses to raise with us. We do not allow companies to raise on our platform who do not pass our enhanced scrutiny checks, and we turn away the vast majority of businesses that approach us each year, because they do not meet our stringent criteria standards.
At Seedrs we aim to be as transparent as possible about everything we do and are committed to making a complicated and confusing topic as accessible as possible for both investors and entrepreneurs. As a result, our Chief Investment Officer, Kirsty Grant, has published our approach to due diligence so you can understand what steps we undertake in the process, and equally as important, what steps we don’t undertake: The Seedrs Standard: Guide to Due Diligence
We hope you found this guide useful and you feel armed with the knowledge to confidently conduct due diligence when discovering businesses to invest in on Seedrs.