From tiny seeds big things grow

Start-ups may offer great potential for investors, but first do some spadework

WOULD you believe four of the five most valuable listed companies in the US started in the past 30 years as part of the current technology revolution?

Apple, Facebook, Google and Microsoft all began as start-ups not that long ago.

By comparison, the top end of the Australian share market is still dominated by banks and resource companies. But we have a thriving start-up community where big money has been made backing a great digital idea.

A warning. Direct investing in an early-stage start-up is high risk and you need good expert advice, an appetite for risk and diversity across a few businesses.

As an alternative, we’ve listed a number of start-up incubators/accelerators that have launched investment funds to support their alumni. These funds provide diversity and a bit of comfort that the start-ups have a structured development program.

Also a number of start-ups have listed on the Australian Stock Exchange to fund their expansion, meaning investors can buy in, and exit, a lot easier. But, again, you need to get your own expert advice.

A good way to learn is to subscribe (it’s free) to the email newsletter Start-Up Daily.

Here are five questions to ask before investing in any new start-up business.

WHAT’S THE EXIT STRATEGY?

Every business should be planned with exit in mind. This might sound a bit downbeat, but it ensures the business is built with good processes that allow it to be efficiently run by any buyer. And when it comes to selling out, this becomes crucial.

Any business partnership or investment must include agreement on the procedure if one partner or investor wants to sell their stake.

WHO ARE THE KEY PLAYERS?

The record and reputation of the people at the wheel is very important. A great business can be run into the ground very quickly by poor management. You also want to see the founders keep a decent chunk of ownership – this helps keep everyone’s interests aligned.

It’s also worth looking into who the other investors are and what the ownership structure will look like after the business has finished getting investors. Management is accountable to you and the other investors, so ensure they’re of good mind and reputation too.

DO THE NUMBERS WORK?

Make a thorough check of the numbers before getting the wallet out. This isn’t just seeing a short sales record and the potential for more … it’s a close look at whether the venture can provide a fair return for the risk you’re taking.

A common way to weigh up financial projections (which any new business should have) is to look at whether the numbers work when sales are below expectations or costs blow out above what’s budgeted.

By making a conservative assessment of the base case, hopefully the only earnings surprise will be a positive one!

WHAT’S THE MARKET PLAN?

A great product or service is of no value if people won’t pay for it, whether in sales, sponsorship or licensing. So ask a business what the market looks like and how they plan to capture it. Again, this is basic information that every business should have on hand – customer profiles, competitor analysis, market positioning, marketing strategy … all evidence of exactly why their business will flourish.

A lot of this information forms the basis for the forecast numbers you’ve reviewed, so ticking off each of the inputs and the reasoning behind them is as important as testing the forecasts.

DO YOU KNOW WHAT YOU’RE DEALING WITH?

The fifth question to ask is of yourself. Be sure you understand what’s involved and the area the business is operating in.

For example, investing in an app-building business makes no sense if you don’t own a smartphone. As a potential business owner, you need a working knowledge of the area. An expert background is even better.