5 Ways to Spot High-Potential Startup Investments

The best venture capitalists share something in common: They know how to tell whether an opportunity is worth the investment. You don’t need to have millions of dollars to be a successful investor, either — even smaller investments can pay off if you enter early and find the right startup. Over time, you’ll be able to hone your skills, grow your capital and diversify your investments.

Although early-stage companies can provide great opportunities to invest, not every opportunity that comes your way is worth the risk. Over the years, as a venture capitalist and fund manager, I had the chance to look at hundreds of opportunities and narrowed them down to a number of promising early-stage investments. From establishing a strong deal flow to creating a checklist of must-have documents, here are five tips to help you spot high-potential startup investments.

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It’s all about networking

If you’re wondering where to begin when it comes to sourcing early-stage investment opportunities, the answer is: It’s all about networking. The most successful venture capitalists have thriving personal and professional networks that allow them to create what’s known as a “deal flow.” This is the rate at which new investment opportunities are being pitched to you.

Want to establish a strong deal flow for yourself? Take the time to connect with other investors in person and online, and make it clear what types of opportunities you’re looking for. Any early-stage deals you aren’t interested in should be passed along to others in your network, as this will help solidify your connections and ensure that opportunities are sent your way in return.

Another valuable aspect of networking is the ability to invest much smaller amounts of capital into early-stage startups during “family and friends” rounds of funding. This is a great opportunity if you’re looking for lower-risk investments or just starting out as an investor since you’ll be able to get in on a new company early without having to leverage large amounts of capital.

Set your hard limits

As you develop a strong deal flow, you’ll get many early-stage investment opportunities put in front of you. This is when it becomes important to know exactly what you’re looking for and set hard limits on what you won’t accept. Take the time to sit down and write out a list of hard “nos” or red flags that you’ll avoid (i.e. being required to sign an NDA).

These personal limits will be crucial as you begin to review hundreds of proposals because oftentimes, personality or dazzling pitches can distract from overall issues in a startup opportunity. Even if a pitch sounds great, your predetermined guidelines will keep you objective and analytical in your process. This way, when it comes time to make tough decisions, you aren’t acting on emotion or personality — you can instead easily filter out companies that just aren’t a match.

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Look at the bigger picture

If you’ve found a pitch that seems enticing with properly vetted due diligence, you’ll want to take a step back and look at the bigger picture. What is the market like for this proposal, and are there already other competitors in the same space? Is there a customer base and how much potential growth exists in that space?

Try to fully envision the life cycle of the product or service from the point of view of the customer and imagine hypothetical scenarios in which pain points could arise. You’ve likely been presented with a very specific, tailored point-of-view from the startup, so work backward and expand your thinking outside of the box that they’ve shared with you. If the proposition still makes sense and few issues arise, you’ve got a great investment opportunity.

What’s the risk?

With any early-stage investment, there will undoubtedly be risks. It’s your job to figure out precisely what that risk is, how long it will last and how solvable it is. There are many different types of risk, from technical to the team to intellectual property.

Technical risk, for instance, refers to the chance that the product simply can’t be built — so you may want vetted expert opinion if the investment opportunity relates to technology you’re unfamiliar with. Or there’s team risk, which refers to the character of the management team, so trust your instincts if you feel any moral or ethical concerns relating to the personalities of the people you’re working with. After all, if you choose to invest, you’ll be working with the company for quite a while.

Related: Is It Worth It? 5 Ways to Identify a Promising Business Investment

Imagine the future

As an early-stage investor, you’ll need to be able to think long-term. How will funding change over the next year, five years or 10 years? Any strong startup should have a prepared growth strategy, which will relate to funding.

You’ll want to know how long the company has before it runs out of funding entirely, as well as how much financing it will need so that you can eventually exit. And when it comes to exiting the company, you should be thinking about this during early-stage investments — after all, it’s an inherent part of what makes the opportunity attractive. What would make someone want to purchase the company eventually, and what’s the roadmap to getting the company to that point?

The takeaway

Investing in a startup is no easy feat, but with the right diligence, early-stage investments can be incredibly rewarding. By creating a firm structure you can follow as you review pitches, you’ll be able to sort out promising opportunities from time-wasters. Be sure to stick to your pre-established processes and think long-term to build a diverse portfolio — and reap the rewards that follow.