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5 green flags for startup investors

Understanding obvious green and red flags helps you make better-informed decisions and increase your chances of success.

Jul 17, 2023 — 4 min read

We have already covered the red flags of angel investing, but when considering an investment, it’s equally important to notice the characteristics of the company that make it stand out from the competition. From a strong founding team to capital efficiency, we’ve listed the core factors to predict future success. Of course, investing in startups is always a risk, but you can’t build a strong company on a weak foundation. The more boxes you can check for a startup, the higher the probability of a successful investment. What should you pay attention to?

1. Strong founding team

The founding team is the backbone of any startup. A strong founding team has the right mix of experience, skills, and passion to help the startup succeed. Here’s what to look for when evaluating a startup’s founding team:

Industry experience: Look for founders who have at least 3 years of relevant experience to make sure they understand the industry and the market. For example, for building a fintech startup, it’s good to have experience in finance or banking.
Startup experience: It's always a good sign if at least one of the founders has successfully built and sold a startup before. This shows that they can navigate the startup ecosystem and know what it takes to succeed. But a failed startup can sometimes teach as much or even more than a successful one.
Complementary skillset: The founding team should have a mix of technical, business, and industry-specific skills necessary to build and scale the startup. For example, if the startup is building a new software product, the team should have a mix of software development, marketing, and sales expertise.
Passion and commitment: If the founding team isn’t passionate about their business, who should be? Building a startup is hard work and you don’t last long without commitment and a clear vision. Although passion is hard to assess and mainly relies on gut feeling, take into account their past experiences, their level of involvement in the startup, and their willingness to take risks.

2. Sufficient market opportunity

Even the best team and product can’t succeed if there isn't enough room on the market for it. Here’s what to look for when evaluating a startup’s market opportunity:

Market size: To build a successful business, there must be enough demand for the product or service. This requires a large market that’s on the path of growth. For example, if a startup targets a market worth $100 million, you can expect it to support a company worth about $20-30 million. If a startup targets a market worth $1 million… you can do the math.
Clear target market or expansion path: The startup should target a well-defined market that is accessible and large enough to support its business. Starting on a niche market is not an essentially flawed strategy, it may be a smart route to bigger success – but the founders need to have a clear understanding in which direction and how they want to expand.
Growth potential: Look for a market that’s growing at a steady rate of at least 10% per year. This way the market isn’t too saturated by established players yet and there’s a growing demand for the product or service. This growth can be supported by market trends, consumer preferences, or regulatory changes.
Level of competition: A crowded and competitive market can be challenging to penetrate, while a market with no competition indicates a lack of demand or interest.

3. Compelling and innovative product or service

A strong product or service is the main thing that provides value to its customers and sets it apart from the competitors. It should solve a real problem for its target customers and have a clear value proposition. Here’s what to look for when evaluating a startup’s product or service:

Unique value proposition: Look for a product or service that solves a real problem or fulfils an unmet need in the market in a unique way, e.g. a distinctive selling point or strong product differentiation.
Scalability: The product or service should be easily expandable to a larger customer base. This ensures that the startup has the potential for rapid growth and can generate significant revenue.
Demonstrated demand: Make sure the product or service has actual market demand. For example, this can be indicated by early customer adoption, positive reviews or feedback, or pre-orders.
Innovativeness: The product or service should offer something new or different to the market like a new technology, business model, or customer experience.
Intellectual property protection: The startup should have a clear strategy to protect its intellectual property and core product or service. They should know and understand the basics of patent protection, including, when it doesn’t make sense to file for a patent (e.g. SaaS platforms) and how feasible it is to enforce the protection (sometimes a secret kept can be a better protection than a patent published).

4. Traction

Traction is the progress the startup has made in acquiring customers, generating revenue, and building a strong brand. Here’s what to look for when evaluating a startup’s traction:

Customer acquisition: Look for a startup that can acquire customers at a reasonable cost. Success in acquiring customers can look like a growing user base, increasing sales, or high customer retention rates.
Revenue generation: The startup should have a clear revenue model already generating revenue, e.g. product sales, subscription fees, or advertising revenue.
Branding: Building a strong brand is a long-term investment. Building a strong brand can look like positive press coverage, a strong social media presence, or a loyal customer following.
Repeatable and scalable growth: The startup should have a clear strategy to acquire customers and generate revenue in a stable and sustainable way. Watch out for short-term or wishful thinking.

5. Capital Efficiency

Capital efficiency measures the startup's ability to generate revenue and growth with minimal investment. Here’s what to look for when evaluating a startup’s capital efficiency:

Burn rate: A low burn rate means that the startup can operate with minimal expenses, e.g. by keeping its team lean, overhead costs low, or focusing on fast revenue generation.
Revenue per employee: Closely tied to the burn rate, a startup should generate significant revenue per employee, supporting growth with minimal resources.
Profitability: Not many startups are profitable early on and only about 40% of startups ever turn a profit, but they should have a clear path to profitability. If the business model isn’t sustainable, there’s no way it can generate returns for your investment.

Even though startup investments never have a guarantee, understanding obvious green and red flags helps you make better-informed decisions and increase your chances for success. Be sure to check out our article about red flags.