Should You Buy That Underfunded Startup?

When it comes to investing in startups, especially in the tech sector, headlines are crowded with “unicorns” and “unicorn wannabes.” It’s always the companies that have garnered incredibly high valuations and are collecting round after round of funding that populate the headlines, and for good reason. Whether they’re destined to be the next Lyft, or the next Clinkle, anything in the 7- or 10-figure range is going to turn heads.

But, everyone knows that a true “unicorn” (a privately held company valued at over $1 billion) is a statistical rarity. While the number of unicorn companies has risen dramatically in the last decade compared to the total number of startups launched annually, the number of companies that achieve those mythical proportions hovers “just over 1 percent.”

And that spells opportunity to savvy entrepreneurs and investors, because it means there are plenty of underfunded startups out there that could be a unicorn in hiding, just waiting to fulfill its destiny.

How do you determine which “underfunded” startups have real potential? And, what should you do to take advantage of that situation, especially if the owner is considering selling?

Locating baby unicorns

The first key in learning to identify and select these “baby unicorns” with huge potential is to first understand what is meant by “underfunded.” In this context, underfunded doesn’t mean the startup has no money because it was run into the ground and is therefore no longer of interest to investors. It also doesn’t mean that the business is plugging along at a good clip, successfully bringing in funding, but could use a little more to really take it to the next level.

Both of those circumstances are common enough, and offer their own opportunities for the right sort of investment. But, to qualify as “underfunded” in our sense of the term means the current owner has taken the growth of the company as far as he or she can, without the company really beginning to pick up speed.

The underfunded startup you’re looking for is one that’s lacking both financial and emotional capitol; a business that needs an infusion of cash and heart.

Because of the nature of these elusive opportunities, it usually takes patience and persistence (plus a healthy dose of luck) to spot one in the wild. If you’ve been following the progress of a startup since it launched, you’ll likely be able to spot when they seem to hit a growth and passion plateau. At that point, either the founder picks themselves up by the bootstraps and muscles into the next stage, or things begin to coast.

It’s when the business is “coasting” (aka seemingly running just fine, but no longer growing) that the smart unicorn hunter takes interest.

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How to bag a potential unicorn

The real question that needs to be considered at this point is this: Do you have the necessary combination of skills and passion to take the reins of a coasting company and infuse life back into it?

This isn’t a purely academic question, as it speaks to the level of passion you can muster for the idea, product or mission the startup was built around. Likewise, this won’t be a simple liquidation bailout of a floundering business. Just because you have the cash reserves available to buy doesn’t mean you should.

In fact, your first criterion should be your emotional connection to the business. Then, when you’re sure you are the right person to give the startup the TLC it desperately needs, you can begin investigating the financial details to ensure it’s a wise purchase on paper.

From this point forward, going ahead with the purchase can, and should, follow the same basic workflow as is required to buy any business:

  1. Gather the facts
  2. Do your due diligence
  3. Make an offer
  4. Negotiate a final deal
  5. Complete the transaction

The important thing is to be patient. If you’re really going to capitalize on the perfect combination of passion and opportunity, you need to be willing to keep your eyes open and wait. Then, suddenly, you’ll find it: the rare and gorgeous potential unicorn.

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