How do you Know an Early Stage deal is a Good Investment?

An investor called me yesterday asking if I knew of any sources, or guides she could use to analyse a deal to see if it was a good investment.   It is challenging to make definitive decisions when investing in private companies because the information you would use to make an investment decision about  real estate or a public company are generally not available to the investor.   Yes it is true, you may not have a P/E Ratio to consider, or a robust balance sheet and historical financials, and much of their story is an attempt to predict the future.   Heck, they can’t predict the future in the stock market or the real estate market….otherwise no-one would lose money in those areas….so who thinks they can really predict the future of a private company that is early stage?

In reality, there are many things you can scrutinize with regards to a private company to determine if they are a worthwhile investment.   Keep in mind, the whole idea of being an accredited investor investing in private companies is that there is a strong likelihood you could lose everything.   Money invested in a private company should be money that is not needed, not needed to pay for your kid’s college education or anything else, but when it produces a return of 2x to 10x or more….you know exactly how you will spend it celebrating!

So what do you look for to mitigate risk when investing in the riskiest of investments?   The actual fundamental formula has been proven time and time again and is quite logical actually.   An Class A Management team with a B Grade product/offering is more likely to succeed than a Class B Management team with an A Grade product/offering.   It is kind of like one of those 80/20 rules….  80% of your business comes from 20% of your clients.   I don’t know why these things are almost always the case, they just are.    So the obvious next question is; How do you know you have a Class A Management team?   And that is simple….either they have built a company in the past that produced a return on investment to the founders and investors and/or they are currently executing on their business plan successfully.   Current and past performance are the greatest indicators of likely future success.    A blog entry at said it this way: “We have a template response: 1) Have made money for investors before 2) Have lots of users or 3) Have killer tech.”   (Full entry can be found in link below.)   Both 1&2 have to do with past performance and current performance.   #3 is the other thing you look for.   Does the technology or offering solve a fundamental need or gap in the market and therefore is there little to no current competition?  To build upon that, is the technology/offering protected so that it can’t be stolen or knocked off….protected by patents, copyrights or really well managed trade secrets?  And I’ll add a 4th point to look for….does the go to market strategy make sense and is well thought out?  Do they know how they are going to sell it, to whom, and for what price that makes a profit?    Finally, the decision to invest, after all the above bars are met, comes down to terms.   Sometimes an investor must accept the proposed terms the company puts forth in their Private Placement Memorandum.  Sometimes they can pool their funds with other investors and create leverage to negotiate different terms.     

So what is an angel investor to do?   The number one reason an angel investor that could invest doesn’t invest is because they are uncomfortable with the process….the due diligence process.  It takes a lot of time to meet with a company, review their due diligence, and assess these different strengths and weaknesses.   In our angel investor group, The Network of Business Angels & Investors ( they manage this problem by having a firm do the initial screening to determine that the fundamentals are in place and if it is a management issue, then it is identified up front.  We use the Launch Funding Network’s screening process ( and have angel investor forums about every 6 weeks where companies that have been screened and scrubbed get the opportunity to tell their story.    This saves time for the investor because they get a volume of deals at once and they know that the “sniff” test has been passed.  

 Finding good deals to invest is a matter of having a system that can handle volume and having a community that you can co-invest with and share the due diligence work with.   Most Posting Sites don’t offer any of this.  They just post without any screening or validation.  If you don’t have a community to participate with,  you need to hire a small team to do it for you—lawyers, accountants, business advisors etc.    We like our “country club for Investors” approach.   Have fun and make money too!


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