Exhibit A: a startup with an inexperienced leadership team enters a business sector with notoriously high failure rates: the food service industry. On paper, the startup is likely to be classified as a high-risk venture, signalling a gloomy fundraising outlook — but it doesn’t have to be that way, says veteran startup mentor, angel investor and founder of Startup Professionals, Martin Zwilling.
The key to defying the odds, says Zwilling, is for the startup to acknowledge and address its challenges in its business case and investor presentation. The worst the startup can do is to hope that its weaknesses fall in investor blind spots. The challenge is to point out quickly how any high risk factors are mitigated.
Apart from team experience — investors fund people, not ideas, says Zwilling — and the business sector, which other factors determine risk? Government involvement. For example, a new liver medicine manufactured in the United States will require approval by the Food and Drug Administration (FDA), which can take time. The upside here is that if approved, the payoff could be worth the red tape.
How large is the sum the venture is hoping to raise? If it’s really big — Zwilling gives an example of a US$1bn investment — it’s almost guaranteed to scare investors away. However, if the business can demonstrate high return potential, it could still be a compelling bet. “Businesses with a low growth rate or a small opportunity (less than $1B) are considered high risk by investors, who get measured on portfolio return over time. That eliminates from consideration family businesses, small niches, and business areas with declining growth,” says Zwilling.
Investors also have a public image to uphold. Fringe startups — gambling or porn for example — are likely to face a very limited pool of available investors.
Lastly, Zwilling addresses something that explains why foreign investment is a rarity, even more so in emerging markets. Cross-boundary investments are considered high risk. Generally, investors are reluctant to invest outside their realm of operational knowledge. “We all know that the success “rules” in Russia are different from the USA, even if you have operating experience there,” he says.
Zwilling’s conclusion makes a strong case for founder experience:
In summary, it pays to have some insight into how investors will likely see you, since this allows you to prepare the best case, both for your own decisions, and for approaching an investor. It’s never smart to switch your plans to a “less risky” business that you know nothing about, because your lack of experience there simply moves that alternative to the high risk category.
Source: Startup Professionals