3 rules to make you a smart investor in startups

Now that anyone can try their hand at startup investing, and any accredited investor has access to deals, the question naturally arises: How do you rise above the maddening crowd in crowdfunding? How do investors get past the hype and discern the good startups from the bad?

With due diligence and educated investment decisions, that’s how. Here are three basic rules of smart startup investing:

1. Get to know the industry

The most important rule of successful startup investors: Focus on industries you know well. Otherwise you’re much more likely to fall victim to hype or overlook poor fundamentals. Without deep knowledge of the specific market in question, a startup’s pitch will be more difficult to evaluate. In these situations, your decision can be swayed by a sales pitch rather than informed by objective, real-world metrics.

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Before investing, thoroughly research the startup’s industry. Better yet, partner with people or institutions that have extensive operating or investing experience in that field.

  is a good example. The run up to Twitter’s IPO was marked by huge demand for shares on the secondary market, mostly from investors with extensive social media experience. In 2012, when MicroVentures raised a fund to invest in Twitter, many types of people wanted to participate, but most of the actual investment activity we saw came from those who were active in the social media space. These investors understood what Twitter was doing on a fundamental level. They had been users since Twitter’s inception and saw clearly the inherent value of the service, Twitter’s objectives in the advertising space, and the potential for growth.

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Another instructive example is a company like Medigram, which is raising money currently. At first glance, most would probably think there isn’t much of a market for a company that is attempting to kill physicians’ pagers. However, more than half the people investing in this company are doctors: They understand the need for this service in the medical community. These are the exact investors who have the “on the ground” experience to truly evaluate this startup’s prospects.

There is no shortcut here: you need a good understanding of the industry you’re investing in. If you don’t, it’s best to steer clear.

2. Get to know the concept

Of course, you also need to consider carefully what the company is trying to do. The first question an investor should ask is, “What makes this idea unique?” You need to figure out what separates this company’s idea from its competitors.

Bill Clark

Investors should also understand whether the startup’s idea is even feasible. If so, how easily could competitors replicate the business? It’s critical to uncover intricacies in a startup’s strategy or product that will allow it to gain market share and fend off competitors.

Also, look for companies with products or services that will save people time and money, and which users can easily adopt. Does this startup offer something the competition doesn’t, and that larger competitors may have trouble replicating? And consider whether the startup might be acquired: Investigate the acquisition dynamics in the space and consider how that will affect your startup’s exit prospects.

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 is a good example of a company that entered a seemingly crowded field with entrenched competitors. Facebook’s winning strategy has been to penetrate a niche market wherein they could quickly gain traction and expand.

3. Get to know the management team

When you invest in a startup, you’re really investing in people. Even the best ideas don’t mean much without people who can implement them. Beyond that, if the initial idea doesn’t work and a startup needs to pivot, a great team can make all the difference between success and failure.

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When you invest in a startup, be sure that the team you’re backing has the right people to execute the idea and the abilities to execute that plan. Startup incubator program 500Startups, for example, says winning startup teams must have roles for “a hacker, a hustler, and a designer.” This means creating a team with business experience, the technical capacity to build the underlying product or service, and the ability to create a good-looking, functional website that people want to use.

In addition to those basic skill sets, an important question to ask is, “How long has this team worked together?” You need to evaluate how the team interacts and to make sure everyone seems to be a good fit.

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If you’re not in the position to meet with the founders of a company, then partner with a group or funding platform to do that for you. If you fund a company without consulting someone with direct knowledge of the team’s dynamics, you’re taking a risk that could be avoided.

Bill Clark is president and founder ofMicroVentures, an online Venture Capital Investment Bank. Follow him on Twitter at@austinbillc.

More about crowdfunding from MarketWatch:

How to use crowdfunding to invest in real estate

4 ways investing in startups will become easier for you

What to know before you invest in a startup

View more information: https://www.marketwatch.com/story/3-rules-to-make-you-a-smart-investor-in-startups-2014-02-25

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