Investing in friends’ startups can genuinely be an alluring prospect. You believe in them (of course, because they’re your friend), and you want to be a part of something great. You’ve probably heard Apple and Microsoft’s stories and the other companies that were started by friends and which have now grown to trillion-dollar valuation.
Hey, perhaps you both could do the same thing.
However, as the business world has shown from time to time, the fact that your friend started a company doesn’t necessarily mean it will succeed. One of the hallmarks of a great business person or investor is the ability to separate emotions from business decisions. Sometimes, this means having to pass up on a friend’s company.
Still, there are some companies with significant potential that you can’t ignore. Finding that balance (a company started by your friend that also has significant potential) is the gold standard. To help ensure that you don’t make the wrong decisions, here are some important questions you might need to ask and the factors you need to consider.
Your Friend’s Business Experience
Perhaps the most important question that could determine if investing in a friend’s startups is a good idea will be the friend’s experience at scaling a company. If they have done this before, then you at least know that you’ve got someone with significant working acumen at the helm of your investment.
It will also help if the friend’s business experience is related—even if remotely—to the new company they’re asking you to invest in. This way, you know they understand the industry and should have an easier time navigating it. Eventually, you’ll feel safer knowing that your company is in experienced hands.
The Company’s Business Nature
It’s also worth examining the friend’s relationship with the company and its business model.
Are they passionate about the company’s focus, or is this just a fad that they’re trying to get on?
Is there enough enthusiasm from the friend that you believe they can see this through?
Knowing the friend well will make answering this question much easier. For instance, if you’ve been childhood friends and you know he is passionate about sports, you should feel more confident when he comes to you with the idea of a sports apparel store.
Businesspeople have a higher chance of succeeding when they try ventures that are in line with their life’s passions. So, watch and find out whether your friend is genuinely enthusiastic about this new business opportunity or not.
The Availability of a Market
Moving away from the friend, you should also examine the company and what it’s selling. Of course, this is a step you should take when looking to invest in any business—regardless of your relationship with its founder.
Examine if the product or service the business is offering will have willing buyers ready to pay the asking price. This will involve significant work and study, and you will need to analyze the business’s model thoroughly.
Keep in mind that you will have to make a significant part of your decision based on this question. If you don’t see a path to profitability in a business, the truth is that you won’t be doing yourself any favors if you invest. You’re better off keeping your money and investing in some other venture.
A Starting Customer List
While this isn’t an essential requirement, it does help. Most companies take weeks—perhaps even months—to reach critical mass and develop a healthy customer base. However, some customers already know about them before they launch. In the early stages of the business, these customers will be the most important by a significant margin.
Having people who know what you’re selling and are ready to buy from you will help with steady revenue. These initial customers can also help with some much-needed word of mouth marketing to help get the business moving. Eventually, you will be able to incorporate other marketing structures and develop the business to help reach critical mass.
The Product’s Timing
In today’s business climate, it isn’t enough to have a great product. You also need impeccable timing to ensure that what you’re launching will be received well.
Think of it like this. Netflix has a great business model now, with people paying to access thousands of movies. However, the company might not have made so much money or achieved so much success years back, when movie rentals were easy for people to access.
The same applies to subscription businesses like Apple Music and Spotify. Several other companies have failed—not because they were inherently bad, but because they were ahead of their time. It is vital to ensure that your friend’s company isn’t toeing the same line.
You should also examine the business to ensure that its product or service is strong enough to avoid obsolescence in the near future. There’s no point investing in a company that won’t be around in the next few years. Vet the company and its industry to ensure that it’s substantial enough for you to put your money in.
The business and its structure should also get some proper vetting. Depending on its scale and industry, you want to ensure that you’re investing in a firm with a solid founding and operating team.
You want to ensure that the team members are qualified enough to handle their work and get things done. Check their qualifications and experience, and understand what each person brings to the table.
It would also help if you trusted the teammates. You don’t necessarily need a personal relationship with every team member, but you should at least trust in their ability to get the job done.
The Possibility of Failure
Not every business person thinks of this. Many go into business thinking that they will always succeed and things will be dandy all the time. But, this is business, and there is always the possibility of something going awry.
Now, you’ve got to ask yourself—are you willing to be friends with this person if the business fails? This isn’t to say that the company will fail, but you also need to understand the possibility of failure and be able to live with it.
The Potential Market
Part of doing your homework will also involve providing an examination of the company’s assessment. There are several methods of sizing a potential market. However, three areas where many firms tend to focus on include:
- The Total Addressable Market (TAM): this metric measures the entire possible market for a service or product if customer acquisition was unrestricted and not held back.
- The Serviceable Available Market (SAM): this metric examines the specific demographics that the TAM targets. While TA is more of a broad view concerning the business and its market, SAM takes things at a much narrower level.
- The Share of Market (SOM): this metric considers the total share of a market that the friend’s business hopes to capture and enjoy.
It is important to note that all these metrics have implications for the company’s future. However, it would help if you kept the third metric in your mind most of the time. At the end of the day, the company’s projected share of its market will determine how profitable it can be. As an investor, it should be your most vital metric.
Possible Gaps in Expectations
One of the most fatal mistakes that companies make is to overblow their expectations. As an investor, you would need to look at the prospects and see if the company’s projections are accurate or if there are some gaps in their thinking.
Examine if the startup has investigated all parts of its prospective market. Look into the company’s approach to business, its sustainability, and how it can adapt to future business climate changes. Remember that the business world is highly susceptible to change. What is in Vogue today can just as well fall out of fashion by tomorrow.
Therefore, it is essential to note if the company is being realistic with its projections or not. Ensure that estimates are well-founded and practical, or you could end up being disappointed at the end of the day.
Here are some more things to consider in regards to projections and expectations.
The Financial Projections
If you’re investing in friends’ startups, you should know that what you’re doing isn’t just supporting a friend—you’re also out to make money for yourself. It won’t be smart to commit to a venture that won’t make much in returns at the end of the day.
Most investors tend to look out for a five-year picture. Financial projections should provide conservative, balanced, and aggressive outlooks of the business and its earnings.
For a pro tip, try to check out the firm’s projected break-even point. This is the point where the startup starts becoming profitable if it is not already. It provides an estimate of when you can begin seeing the most sizable returns on your investment.
The Returns Themselves
These days, established businesses have no problem with providing trading histories and other pieces of evidence to back their projections up when they solicit investments. However, the same can’t be said for early-stage startups.
Still, these startups need money, so before investing in friends’ startups, you will most likely get growth forecasts that are done based on theoretical numbers. Part of your analysis will be to question these numbers in detail and to the best of your ability. If you have experience with investing, then you should be able to judge whether these numbers seem realistic or not.
Company Valuation Methods
Companies looking to attract investors often turn to projections of their valuations. There are many ways to get this done, including the First Chicago Method and the Venture Capital Method. While the company can use any method, you will need to run its numbers based on your preferred method too.
Making too much of an investment will eventually come with consequences, so you want to be sure that you’ve reached a fair valuation before investing in friends’ startups.
The Business’s Scaling Potential
Scalability is one of the few factors that will separate a truly viable startup from other lifestyle businesses that will most likely not deliver any returns for you in the long run. So, make sure to look out for this factor.
It would be better to ask if the business model could allow the company to grow its revenues without necessarily increasing its costs. If it can, you’re on the right track.
How They Apply Capital
Before investing in friends’ startups, you will also need to ensure that they have plans for your capital. These plans will ensure that the company delivers maximum growth and development over time.
It doesn’t matter what the plans are. The company might want to spend money on HR, marketing, sales, etc. As long as they know where to allocate every cent raised, you know you’re investing in a serious company.
Additional Capital Requirements
Taking on any more capital could reduce your shares and influence on the business. So, how does the firm plan to make up?
Will the company get grants from the government or bank loans to expedite work? Will your friend seek investments from other people? The company will need a clear vision of the funding capital as it hits milestones and moves forward.
Founders need to get along. Beyond the optics of it all, a healthy relationship between founders will provide additional room for healthy debates between them over business decisions.
While this isn’t to say that things will always be dandy, the founders should be at least cordial enough to reach compromises when they disagree on topics.
There is hardly a time when your business trajectory goes the way of your initial plan. Every business has to deal with unexpected breakthroughs and unforeseen circumstances from time to time, and these could lead it in different directions.
If any of this is the case, the management team—and company workers—should be able to respond accordingly. Pivoting is a drastic step, and everyone needs to be ready for the next shift.
Offering Support Some Other Way
So, imagine you’ve decided on the rational thing, and you’re not looking to invest in this friend’s startup because you don’t think it has the type of potential you’re looking for. Of course, this doesn’t necessarily mean you have to bail on them entirely. Help can be given in different ways, and you can always find other ways to be of assistance.
Here are a few other options to try.
Being a friend doesn’t necessarily mean you only have to dole out cash when it is needed. Part of being a friend is encouraging their endeavor and making sure that they feel the love.
When you can, encourage your friend. Let them know you’re rooting for them and would like to see them succeed. Also, if you can provide some professional advice based on possible business experience, don’t be afraid to do so.
It is also possible that you don’t have as much money as your friend’s startup might need. In this case, getting someone to step in might be the best thing for you—and them. Refer your friend to viable investors looking for opportunities and let them decide whether to make the investment.
At this point, it is crucial not to pressure anyone. If the person you referred doesn’t believe that the business is viable enough to get their investment, don’t hassle them to change their mind. Leave things be. Remember that you’re trying to maintain a relationship with them too.
Promote and Endorse
You might not be able to invest in the business, but there is no reason you shouldn’t support it. Thankfully, there is social media today, and you don’t need to do so much in word-of-mouth marketing. Simply share some of the company’s products or services on your social media pages and give them some much-needed boost. It won’t hurt, you know.
Every business founder could do with some additional knowledge from time to time. As much as you can, feel free to share resources with your friend to help them become even better entrepreneurs.
Invest Your Money Cautiously
When it comes to investing in your friends’ startups, it’s best to treat it like any other investment opportunity. Do not give your friends special treatment simply because they are your friends. In fact, the best way to approach these situations is to establish a personal policy to never do business with friends.
Avoiding making investments into one friend’s startup can save you from many future requests from other friends. Think about it. How much more likely would you be to ask someone for an investment if you know they were able to make a significant investment in someone else’s business? However, if you know that person doesn’t do business with friends, you wouldn’t even bother to ask.
Save yourself the headache and potential heartache by keeping your friendships personal and your investments professional.