When evaluating investment opportunities in high-risk new ventures, business angels decipher their options by adopting a focused and specific approach. They are professional investors, and they act accordingly. Their role is to evaluate investment opportunities; they do not evaluate business ideas or projects. What they want to know at the end of the day is whether the business proposal they are about to assess is capable of generating a determined return on their investment, and also, what role is expected for both the money required, and of themselves! In short, they want to know why and for what the money is raised.
The Five Questions that Everybody Consider…
Let’s first review the five basic “ordinary” issues that everybody, including investors, takes into consideration (or should take into consideration), when evaluating a business opportunity’s potential:
- MARKET
Is there a market that can be identified that has an appealing growth potential? (Does it exist or it should be created? What is the feasibility of entry and to what extent?) - OPPORTUNITY WINDOW
Is this the right time? (Why today? Why not yesterday? Too early? Too late? How long will the window remain open?) - COMPETITION
What is the existing and likely competition? (And to what extent has the sector in which the venture attempts to operate been adequately evaluated, i.e., entry barriers, new entrants, substitutes, customers, suppliers, etc.? What is the profit potential in the this sector?) - BUSINESS MODEL
Does it have an economically, and conceptually viable, business model? (Margins, profits, breakeven, etc. What is the required know-how? To what extent can it be protected?) - STRATEGY
Does it have a focused and differentiated strategy? (Who are the customers? How are they acquired and retained? What is the value proposition to the customer? How sustainable is the competitive advantage? What operating advantages can be gained from focus?)
By weighing these “ordinary” issues investors and entrepreneurs alike are able to better understand how attractive and viable a business opportunity is. However, for investors an “attractive” and “viable” opportunity is a necessary condition but not sufficient to finally support a decision; the opportunity must also be deemed “investable.”
The Other Five Questions that Investors Make (and Entrepreneurs Should Make)
Here we have five additional and specific questions that investors always make (and everybody should make) when conducting a comprehensive assessment of the investability potential of a business opportunity:
- SCALABILITY
Is the concept scalable? (Or similarly, how big could it become, and as it gets bigger and bigger, how much more profitable will it be and to what extent could the concept be easily replicated?) - EXIT
Is there a possible exit for the investor to recover his/her investment with the expected return? (What are the likely options to exit? Can tag or drag along rights be considered?) - CO-INVESTMENT
Can the project attract other co-investors to come on board? (If so, to what extent are they likeminded partners to co-invest with? To what extent can other potential co-investors be spotted within the investor’s own network?) - RETURN
Does the deal provide an adequate return consistent with level of risk implied? (At what stage of development is the project (technology/product, financial metrics/revenue)? What is the probability of getting an IRR of -100%, 0%, 10%, 20%, 50% or 100%? - TEAM
Does it have a complete, committed, compatible and complementary management team (4 C’s)? (Have they work together before? To what extent are their skills complementary? What are the personal objectives/vision of the team’s key members? Are they the kind of people with whom one is able to get on well, and develop a good relationship?)
Investors are always trying to identify attractive business opportunities from good business ideas. However, they particularly need to be very disciplined about selecting “investable” opportunities out of the many business opportunities that they come across. Making an investment decision is a complex process. Knowing what questions to ask can help investors find the right answers to effectively support their decision.
The challenge for entrepreneurs is then to incorporate these questions into their own opportunity self-assessment process. Doing so will improve the quality of the entrepreneurial process greatly for all parties involved. Unfortunately, this does not always occur.