Metrics for deciding whether to invest in a start-up or to forget about it

Metrics for deciding whether to invest in a start-up or to forget about it

Communications

Intuition alone no longer works: the future of many emerging enterprises now depends on metrics and the evidence. Reliable information, transparency, speed of spending, analysis of use, and monetization capability are keys when analyzing their potential for success.

The uncertainty about how the global economy will evolve is affecting emerging enterprises, just like other sectors. In fact, according to data from the specialized investment fund, Atomico, funding for start-ups has decreased because investors are becoming more cautious than ever. Specifically, global funding fell 35% in 2022 compared to the year before.

Flows from investors are dropping. And one of the main reasons could be that only 1 out of every 10 emerging enterprises survives, while the other 9 will fail during the first years of operation, the majority (6 out of 10) due to having created products and services that the market doesn’t need. Yet the failure percentage isn’t quite so high in all countries. In Switzerland, for example, 35% of start-ups manage to land on their feet.

Start-ups that survive take an average of 2-3 years to turn a profit, and almost double the time to eventually go public. According to Statista, 5.3 years in the case of US enterprises. The US is precisely the country with the most emerging enterprises, with over 72,500, followed by India (nearly 14,000) and the United Kingdom (6,300). In Switzerland’s case, according to the radar for Swiss start-ups, over 3,000 emerging enterprises are operational.

According to IEBS (Innovation & Entrepreneurship Business School), the main sectors on which emerging enterprises will venture are renewable energies, mobility, applied AI, foodtech, technology related to Web 3.0, and bioengineering.

To support these types of firms in funding rounds, experts are calling for metrics and evidence to replace investment based on faith or intuition.

There is no infallible formula for judging the evolution and potential for success of a technology-based firm. However, if a start-up is already up and running, there are some indicators that can let us easily understand if it will grow over time and how much

  • The first of these metrics is the financial information of a company. Knowing their level of billing and the income and expense structure, as well as if they have earned a profit or continue to have losses, will provide us with a good X-ray of the state of a company. 
  • There must be information available on the funding rounds to know how much money an enterprise has collected and what stage it is in. It will provide clues about a company’s ability to raise funds and the needs it will have in the future. 
  • In this regard, it is also important, when assessing an investment, to know how fast a firm is spending the funds it obtains. This indicator is called the burn rate, and it is usually measured monthly. The lower it is, the more efficient a company is deemed to be at using the financing it has obtained.
  • Regarding customers or users, not only is it important to quantify their number —easy to do using data on registrations or downloads of an app— but also their level of activity and retention. In other words, it is essential to see if customers are not only using the product, but also how they are using it and how often. 
  • But here the truly important metric is the capability to monetize a product, meaning transform the attraction and retention of users into income, the ultimate purpose of a business. 
  • Moreover, experts recommend taking into account the customer acquisition cost, an interesting metric for being able to see if the evolution is downward or if it is higher than the cost at other companies or in other sectors.
  • In the case of a company that has a product or service sales model, it is essential to know the economic margin being pursued by the company. By this we mean the difference between the average selling price of a good and the cost of producing it for the company. 
  • And finally, it is necessary to study the way in which money is recouped and the extent to which other investors have already done so. Having to wait for a dividend is not the same thing as being able to disinvest. 

First steps

The aforementioned metrics will become important to the extent that a project grows, but if an enterprise is still in the seed stage or not operating, there won’t be much data on these indicators. 

In this case, we’ll have to base our assessments on more subjective issues that always have to be taken into account before deciding to invest. For example, who the entrepreneurs behind the project decisions are, what the business plan is, an analysis of the product on which the entrepreneurial idea is based, and the characteristics of the target market

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