Professional investors don't guess. They use frameworks.The difference between a successful pre-IPO investor and someone who loses money usually comes down to due diligence quality. VCs spend 50-100 hours evaluating each deal. Most retail investors spend 5 minutes.This guide gives you the professional framework in 5 actionable steps. Follow it before every pre-IPO investment. For the valuation math behind Step 4, see our companion guide on calculating startup valuations.
Step 1: Evaluate the Market OpportunityGreat companies need great markets. Before anything else, assess:Total Addressable Market (TAM)How big is the market the company is targeting? Look for markets above $10B - smaller markets limit upside.Market Growth RateIs the market growing? Declining markets create headwinds. Growing markets provide tailwinds. Check industry reports and analyst projections.Market TimingIs the timing right? Too early means the company burns cash waiting for adoption. Too late means incumbents have won. The sweet spot is emerging but validated markets.Red flag: Company creating a "new market" with no existing demand. Green light: Growing market with clear pain points the company solves.
Step 2: Analyze the Business ModelNot all revenue is equal. Evaluate:Revenue ModelHow does the company make money? Recurring revenue (SaaS, subscriptions) is more valuable than one-time sales. Marketplaces with transaction fees have network effects.Unit EconomicsDoes the company make money on each customer? Key metrics:LTV (Lifetime Value): How much revenue per customer over their lifetime?CAC (Customer Acquisition Cost): How much does it cost to acquire a customer?LTV/CAC ratio: Should be 3:1 or higher for healthy businesses.Competitive MoatWhat stops competitors from copying this? Network effects, proprietary technology, brand, switching costs. No moat = race to zero margins.Red flag: No path to profitability, LTV/CAC below 2:1. Green light: Recurring revenue with clear moat and improving unit economics.
Step 3: Assess the TeamIdeas are cheap. Execution is everything.Founder BackgroundResearch on LinkedIn, Crunchbase, and Google:Have they built companies before?Do they have domain expertise in this market?Previous exits or failures? (Failures with lessons learned can be positive)Team CompletenessDoes the team have all key roles filled?Technical co-founder (for tech companies)GTM/sales leaderFinance/operationsInvestor QualityWho else has invested? Top-tier VCs (Sequoia, a16z, Benchmark) provide validation and support. Unknown investors may indicate red flags others caught.Advisor NetworkQuality advisors with relevant experience indicate the team knows what they don't know and seeks help.Red flag: First-time founders with no domain expertise, no reputable investors. Green light: Serial entrepreneurs with relevant experience and top-tier backers.
Step 4: Understand the ValuationGreat companies can be bad investments at wrong prices.Valuation MultiplesCompare to public market peers:Revenue multiple: Valuation ÷ Annual Revenue. SaaS typically trades at 5-15x, but varies by growth rate.Growth-adjusted: Higher growth justifies higher multiples, but within reason.Entry vs Exit MathWork backwards from potential exit:If company IPOs at $10B and you buy at $1B valuation, potential 10x return.If company IPOs at $10B and you buy at $8B valuation, only 25% upside.Late-stage investors often buy near exit valuations - limited upside.Historical FundingWhat did earlier investors pay? Big step-ups between rounds without proportional progress are warning signs.Red flag: Valuation 3x+ public market comparables, or massive recent markdown. Green light: Reasonable valuation with clear path to higher exit multiple. Case studies like Stripe's valuation journey illustrate how dramatically private valuations can shift.
Step 5: Evaluate Deal TermsNot all equity is equal. Understand your position in the capital stack.Share ClassAre you getting common or preferred shares? Preferred shares have liquidation preferences - they get paid first if the company sells for less than expected.Liquidation PreferencesA 2x liquidation preference means investors get 2x their money back before common shareholders see anything. This can wipe out your returns in mediocre exits.Pro-Rata RightsCan you invest more in future rounds to maintain your percentage? Important for protecting against dilution in high-growth scenarios.Information RightsWill you receive quarterly updates, financial statements, board materials? More transparency is better.Red flag: Heavy liquidation preferences, no information rights, complex share structures. Green light: Standard terms, reasonable preferences, regular reporting.
Common Mistakes to Avoid1. Falling for the StoryGreat pitch decks don't equal great investments. Verify claims independently.2. FOMO Investing"Hot deals" that pressure you to invest quickly often have hidden problems. Good deals allow time for due diligence.3. Over-concentrationPutting too much in one deal is the fastest way to lose everything. Diversify across multiple opportunities.4. Ignoring ValuationGreat company + wrong price = bad investment. Always do the math on potential returns.5. Skipping Due Diligence"Everyone else is investing" isn't due diligence. Do your own work.
Tools and ResourcesCompany ResearchCrunchbase: Funding history, investors, key peopleLinkedIn: Team backgrounds, company growthGlassdoor: Employee sentiment (warning sign if very negative)Product Hunt: User feedback for consumer productsMarket ResearchCB Insights: Industry reports, market mapsPitchbook: Valuation comparables (paid)Industry publications: Trade news, analyst reportsPlatform ToolsIPO Genie provides AI-powered scoring that automates much of this analysis, saving you dozens of hours per deal while ensuring nothing is missed.
Frequently Asked QuestionsQ: How long should due diligence take?For significant investments, plan 10-20 hours minimum. Read all available materials, research the team, verify claims, and run the numbers. Shortcuts cost money.Q: What's the most important factor?Team quality is often most predictive. Great teams can pivot mediocre ideas; mediocre teams struggle even with great ideas. But valuation determines your returns.Q: Can I trust the company's projections?Assume projections are optimistic. Discount revenue forecasts by 30-50% and see if the investment still makes sense. If it only works with perfect execution, the risk is too high.Q: How many deals should I evaluate before investing?Professional VCs review 100+ deals for every investment. You don't need that volume, but evaluate at least 5-10 opportunities to calibrate your standards before committing capital.Q: What if I can't access all this information?Limited information is itself a red flag. Quality opportunities provide data rooms, financial statements, and access to management. If a company won't share information, don't invest.
