• Post category:Articles
  • Post published:23 May 2022

Considering A Startup Investment? Look At These 13 Signs Of Legitimacy

It can be exciting to get in on the ground floor of a startup with big potential, but as the Theranos story has shown, it’s essential to be wary of any hype and do your due diligence.

23 May 2022

It can be exciting to get in on the ground floor of a startup with big potential, but as the Theranos story has shown, it’s essential to be wary of any hype and do your due diligence. Before investing in a startup, an investor needs to make sure that it’s a legitimate business venture, created by the book, and that the founder can fully explain and back up the claims they’re making about the potential of their product or service and their current financial situation.

To protect your money and interests, there are important factors to examine before investing in a startup—even (or especially) one that’s surrounded by a lot of hype. Below, 13 Forbes Finance Council members share the details a prospective investor should look at to ensure a “promising” startup is legitimate.

1. The Team’s Skills

While every investor would love to get in on the ground floor of a unicorn, they’re called unicorns for a reason. So instead of hunting a mythical creature, investors should spend time getting to know the team to make sure they have the skills that match the company’s current needs. If it’s a startup, they need to be able to raise money and create. If it’s a later stage, they need to be able to grow. – Jeff Grobaski, Epic River

2. The Founders’ Track Record

Looking at it from a venture capitalist view, you’re investing in the founders. What’s their track record? Do you get along with them? Is the team strong? What obstacles or difficult situations have they successfully navigated in the past that prove they’re able to pivot and find a way? – Randal McLeaird, Ridgeline Investment Group

3. The Energy Of The Business

Trust your gut. What are your instincts about the founders? How passionate are they about getting their product(s) to market? What kind of energy do you feel when you walk into the business? Is there a subtle buzz of excitement? Are the employees talking to each other? Create an internal checklist that can alert you to red flags. These intangibles can speak volumes about a startup’s legitimacy. – Amanda Dixon, Barney

4. The Leader’s Internal Qualities

Everything rises and falls on leadership. Ensure that the leader is beyond smart. Patrick Lencioni, author of The Ideal Team Player, says to look for people who are “hungry, humble and smart.” Don’t forget the “humble” part, as a lack of it has led to the demise of many great ideas and thought leaders. – Darryl Lyons, PAX Financial Group, LLC

5. The Company’s Data

Legitimacy (or a lack thereof) is often hiding in the company data. Look for what’s actually happening with the company’s products and services. Is there a real track record? Is the data logical and reliable? Is there a neutral third party who can ensure credibility? – Russ Zalatimo, HUDSONPOINT capital

6. The Market For The Startup

A pitfall startups commonly encounter is overestimating the size of their market. Some niches and products are so single-minded that it’s almost impossible to scale a business from a startup to a large company, even if the startup outperforms the competition. Thus, it cannot be overstated how critical a large and growing market is for startups. This will determine if your investment is a good one. – Mara Garcia, Phonexa Holdings, LLC

7. The Weak Link

If you can’t understand the weak link in the chain, pass. The Theranos story sounded great on paper, and the business model looked really attractive—as long as the technology worked. But it didn’t. The chain broke. Engineers and scientists can now tell us why it didn’t work, but the risk was always there. An average investor probably could not have understood the technology. – Todd Sixt, Strait & Sound Wealth Management LLC

8. The Startup’s Management Team

Before investing in a startup, look at the startup’s management team. What are the track records of the key players? Look for tangible results, and ask what their involvement is in the company. Look for a management team that is equally involved and that has demonstrated results. Think of it as hiring employees: Are these the people you want working for you? – Jared Weitz, United Capital Source Inc.

9. The Company’s Physical Operations

Don’t just accept pro forma numbers on a spreadsheet. If you’re investing in a startup—especially in a private placement situation—it’s a good idea to get eyes on the company’s physical operations. Financials are easy to fake, but brick-and-mortar operations are harder to fabricate. – Glenn Hopper, Sandline Global

10. The Startup’s Customers

It depends on what stage of the company you are investing in. If you are assuming the product actually works, make sure you talk to at least two active customers. During that conversation, get their honest feedback on the product and if they are planning on renewing and expanding their use. Also, make sure they are a true paying customer, paying full price. If not, you will get a skewed view. – Aaron Spool, Eventus Advisory Group, LLC

11. The Founder’s And Leadership’s Drive

When investing in a startup, you are actually investing in the vision of the founder. The leadership team is second. Are they seasoned and ready to hit the door running? Or is this their first rodeo? The founder and the leadership team are what make a startup tick, so look for high EQ paired with the drive and gas to mold the vision. Projections are important, but the leadership to make it happen is even better. – Cynthia Hemingway, Fourlane, Inc.

12. The Company’s Cash Flow

Investors should keep a close eye on how a company is handling its cash flow and check that the numbers look realistic. If an owner isn’t properly collecting payment from their clients, is overextending themselves frequently or is underspending on important tools or research, then they might not be a good investment. – Nick Chandi, ForwardAI

13. The Capital Invested To Date

It is important to know how much capital has been invested to date, along with who the prior and future potential investors are. The investors, the structure and the valuation are all critically important to the future of the enterprise. Make sure you look for partners with a good track record who are aligned with your investment thesis and can build a pathway for liquidity and return on investment. – Peter Goldstein, Exchange Listing LLC

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