3 Questions Startups Should Answer Before Seeking Out Investors

Our region is bursting with exciting high-potential technology startups. These startups spring from many types of environments: universities, laboratories, neighborhood watering holes, and even dinner tables.  Once an idea is born, the next steps are critically important to its long-term success. A solid foundation must be built for a technology startup to thrive. Due to the highly competitive and fast-paced nature of this sector, the preference of the startup may be to seek out investors to fund research and development. I would suggest that the following three questions be considered and answered before the search for investment begins:

Question 1 – Is the technology a product or a business?

Technology startups usually begin with an idea. This idea grows into a team of people working to determine the idea’s market viability. During this process, the team should think about the long-term, big picture goal. Is the goal to sell the product or component to perhaps a large medical device manufacturer or to a software company?  Or is the goal to begin a business, which brings with it the manufacture of a product (or more than one product) and sees it through to its final sale in the marketplace?

Danger exists when a startup thinks that it has a business but actually only has a product or component. In this case, the startup may enter into long-term contracts for buildings and machines and invest more in its workforce than necessary. Overinvestment could put a startup in a weakened fundraising position.

Question 2 – How likely will the technology succeed in the market?

To address this question the startup must formulate its business plan. The business plan must demonstrate the strength of the science and prove that it fulfills a missing market need. It must also have at least an estimate of what it might take to develop the idea into a commercially viable product, including consideration of any regulatory requirements.

The formation of a business plan can be achieved through a variety of channels. There are great business incubators that can help with this process.  Conversely, there are consultants, with proven talent in the industry, who would love to trade their services for a piece of the pie.  Both methods can work. Startups who utilize consultants should choose carefully. In rare circumstances, consultants will discontinue their services part of the way through a project, for reasons ranging from disbelief that the science is viable to mistrust in the management team. Depending on the terms of the consulting agreement, a disinterested consultant could have equity in a startup that they never completed a project for.

If a startup decides to trade equity (options, warrants, stock) for consulting services, there are also some important accounting and tax issues to be considered. 

Question 3 – Is there a strong and trustworthy management team in place? 

In the eyes of investors, the management team is as important as the science and its marketability. Funding sources will look to the management team and base their investment decision heavily on it. Sophisticated investors know that no matter how great the technology, if the management team is defunct, it may never succeed in the market.

These skills are expensive to come by and due to the high level of risk inherent in a startup venture, it can be hard to recruit a star management team. In future posts, we will describe ways to attract the talent that you need by offering incentives including a common one, the issuance of stock options.

Startups that can effectively answer these three vital questions will be more successful in negotiations with funding sources. Without a solid business plan proving the market need for the idea and lack of a trustworthy management team, investors will perceive a higher degree of risk, which will make the terms of investment options less equitable for the startup.