Dmitry Mishunin founder & CEO at HashEx Blockchain Security.
It’s hardly arguable that to invest in startups, one has to know what they’re dealing with. But how deep should an investor dive into the matter?
What A Fund Looks For
According to the more modern methodologies of investment decision making, the most important things for a fund to evaluate are the team and its leader. Many investors tend to look at how these people think, their flexibility and their goals. When the evaluation is approached this way, the ability to read people becomes a highly relevant skill.
One such example is Airbnb. Despite the flawed initial concept, Y Combinator believed in the team. After a pivot that brought the company to what we know today, it was the team that brought the project to success.
Now, let’s imagine the founder is clever and charismatic, that the project has good prospects and that the fund is prepared to move forward. The next logical step is the money—or rather, the way the project intends to earn it.
When we get to the project’s financial plans, the economist has to take a close look at the business model while the marketing team goes through the growth plan. While there is always a margin for error in assessing any project’s profitability, this is one of the most crucial steps in making a decision regarding investments.
The “fake it till you make it” approach is known to everyone. If whatever the company wants to offer is enough to forge interest in the project, the product will do well. If the offer is not enough, however, the product will have to be exceptional to be successful after the launch.
The third step is taken by the technology at the foundation of the project or the service that the company in question offers. Here’s where the issue gets confusing: Shouldn’t technology be one of the first things considered? Unfortunately, this generally is not the case. Many investors are only interested in money over the project, and they exit projects before the product is launched—leaving it for the rest of the investment rounds.
Conveniently, the next rounds might not even happen if the technology isn’t impressive. Many investors tend to avoid risky ventures, so logically, they have to check and review the technology.
We can imagine the complexity of some of them, and very few investors have the time or skill to dig through documentation on spaceships or black boxes. This requires people with very specific skill sets. Of course, every fund possibly has in-house professionals to deal with these projects, but even they can’t know everything. If you hire a Web3 expert, they won’t be able to assess the technology behind a video game.
That’s the point. If a fund even has a technical department, its focus might be spread thin. The nuances can escape the attention.
What Funds Should Do
Two heads are better than one, so it’s best to include experts in the specific field the company plans to operate. There are several reasons for this:
• A third-party expert will have a fresh look at the technical specifications of the project. If the project owners have missed anything or consciously tried to hide anything from the investors, an expert might notice that and call the investor’s attention to the issue.
• Often, founders are focused on their decisions. Knowingly or not, they allow adjustments that suit their initial vision. In these situations, a third-party expert may serve as an advisor and guide their attention to a different solution.
• Security professionals can help minimize possible vulnerabilities. They know all of the details and trends in the field, and there usually is no better judge than someone who constantly works in a specific area.
• Professionals usually tend to know other prominent figures within the industry as well as their reputations. A fund is much better off benefitting from this knowledge.
• A professional security analysis is a necessary part of any project. Just like considering all of the security risks in a regular business, it’s also applicable to startups—especially those dealing with users’ money.
The most important issue that would certainly require outsider participation is security. While in-house specialists can at least address most problems, the safety of the technology is a vital element that can’t afford any mistakes.
Tech Startups And Security
For tech startups, possible vulnerabilities can lead to the most serious damages. Through the first four months of 2024, Web3 projects had already lost over $401 million to various hacks and attacks. Some of the projects were well-funded, which undoubtedly affected their popularity among users. An investment fund’s involvement is supposed to mean that a thorough security audit was performed before launch. When we say security audit, we don’t mean just one company’s perspective.
One thing we often recommend to clients is to get a second opinion, and not because another auditor might put their minds at ease regarding a discovered vulnerability. On the contrary, projects should make sure (for their own sake as well as the sake of their users) that the security chain has no weak links. Otherwise, financial losses aren’t the only issue facing the startup. Reputation is not as hard to obtain as it is to regain. That concerns both the project owners and the funds.
Investment funds may know exactly what their priorities are. The profitability and the potential of the products are absolutely relevant. However, none of that matters much unless the project is safe to use. That’s something funds should be focusing on more.
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