Monday, December 16, 2013

How Investors Choose Early Stage Startups

Freddie Achome
Investing in high tech start-ups is not something for the weak at heart. No matter how great the product or service might be, the company does not have a lengthy track record or proven sales to promise high profits to the potential investor. But investors who choose well are apt to be heartily rewarded when, or rather if, the start-up makes the big time. 

So what is the methodology behind the selection? Investing in high tech start-ups has become a specialized industry of its own, attracting investment managers and funding opportunities. A study analyzes the factors that venture capitalists employ when investing in early stage high tech companies in Europe.

Three Types of Ventures Capitalists

The venture capital industry began gaining strength in the 1990s. Studies on how investors decide whether to invest in a start-up have shown that investors can be divided into three types: investors focused on financial data, investors focused on technological ideas and investors focused on the quality of the human capital. Each type of investor measures a company’s worth or potential using different criteria. 

For instance, the company’s team and its leadership are vital to human capital investors. While the financial situation is important, market size and expected growth are not as critical. Investment managers who look at human capital are usually very well experienced themselves in start-ups. Their investments tend to lean towards industrial automation. 

Investors focused on financial data, on the other hand, base 25% of their decisions on ROI expectations. The investment managers for this group tend to be those with the least amount of experience. 

The third group, or technologically-focused investors, is mainly interested in forming a tight relationship with the start-up’s founder and in the ability to protect the company’s technology. Since they also look closely at market prospects, ROI and the leadership characteristics, their choices are possibly the most well balanced.

Knowing Your Investor

Being familiar with the three types of investors helps venture capital companies build solid investment teams. Likewise, high tech entrepreneurs can more easily find appropriate funding by matching their companies with the most suitable type of venture capital firm.