Here at The Startup Investor, my team and I aim to create an environment that values open communication and honesty. In short, we tell it like it is.
So, on that note… I’m going to be brutally honest for a minute.
I hate investing in businesses that need more and more capital as they grow.
I don’t mean that a startup should be able to turn its seed round into billions of dollars (while not impossible, it would be quite an anomaly). After all, nearly every early-stage company will need to raise more money at some point in order to grow larger.
But what I really can’t stand is a business model with razor-thin margins – especially when those margins fail to grow as time goes by.
It all comes back to scalability – a company’s ability to expand, whether geographically, demographically, or by way of more offerings, in order to become more profitable. A business model that scales well is one of my core requirements for every angel investment I make (more on that here).
Startups that aren’t poised and ready to “take over the world,” or at least to try, aren’t likely to get much more from me than a quick “thank you for your time.”
But having the ability to expand globally isn’t quite enough. I look for startups that will need less and less money the bigger they get.
Apps and software companies are perfect examples of this.
A lot of people think that building software is cheap or easy. It’s neither. The up-front cost can be massive – I’d guess that popular apps like Snapchat and Instagram probably cost between $100,000 and $250,000 in software development alone.
But once that app is built, profit margins grow quickly. Why? Because the cost to distribute software is pretty much negligible. You don’t need to hire a sales force or pay a factory to manufacture more of your product.
As an investor, tech startups that build viral apps or industry-changing software are like big, shiny pots of gold.
It’s not just that high margins make it faster and easier to achieve a return. Keep in mind that the less cash a startup pulls in from investors, the larger your share of the company will be – in other words, you’ll be contending with less dilution.
Not all home runs are tech companies, and not all tech companies are home runs. But capital efficiency is a key consideration of mine when I’m looking to invest – and it should be for you, too.
Until next time,
4 responses to “Our Foolproof Strategy to Avoid Sinkholes”
May 16 2019