Startup Investing: Risks, returns and growth phases
Startup investing is not for everyone. In a previous article I talked about Crowdfunding. The article looked from the side of the investor, but not that of the company applying for crowdfunding. These are usually startups and today we will look at the various stages and investors associated with them.
Phase 1: Bootstrap and Pre-seed
It is the initial phase of the startup, where the idea takes shape and is validated through the research of a market and the verification of the existence of a demand for the product/service offered. In this phase, the resources available are mainly friends, relatives or business angels. The startup is mainly made up of the idea and its founder.
The greatest risk is linked to the uncertainty of the success of the product on the market. Furthermore, the team may not have the necessary skills to carry the project forward and the funding may not be sufficient to cover all costs.
Phase 2: Seed Stage
The Seed stage refers to the stage where the startup is starting to seek funding for its business, often before it has a full product or a large customer base. At this stage, investors can provide funds in exchange for a small ownership stake in the startup. Typically, investors in this stage include as the stage before friends and family of the entrepreneur. But informal investors (also known as Business Angels), or startup accelerators and incubators usually enter in this stage.
The risks associated with the Seed phase are high, as the startup has not yet demonstrated the validity of its product or service on the market. As a result, investors in this stage run still easily the risk of losing their entire investment . However, the potential return can be very high. Investors entering a startup at this stage can obtain a significant share of ownership for a relatively low price.
The average time for the Seed phase is usually 6-12 months. During which the startup tries to develop its product, test it and gain its first customers. At this stage, the startup is still forming its team and working to get the first funds.
Phase 3: Early Stage
The Early Stage refers to the stage in which the startup has developed a working product or service and gained its first customers. In this phase, the startup seeks funds to finance the growth of its business and acquire a larger market share.
Investors in this stage can include venture capitalists (VCs) and investment funds, as well as business angels and accelerators. Investors at this stage are still at a high risk, but at lower level. The startup has not yet demonstrated that it has a long-term viable business model, but something works at least in the short term. However, the potential return is still high. The startup has proven that they have a product or service that has a market.
The average time for the Early Stage is usually 1-3 years. During which time the startup is looking to grow and capture a larger market share. At this stage, the startup is also developing its team and acquiring skills and knowledge to scale the business.
Phase 4: Late Stage
The late stage of investing in a startup is characterized by the presence of institutional investors and significant fundraising activity. In this phase, the startup has reached a certain maturity and stability, and is generally considered a less risky investment option than in previous phases.
Investors who participate in this phase seek to profit from the increase in value of the startup and any cash flows generated by the operating activity. However, the return on investment may take longer than in the previous phases, as the growth of the startup may be slower.
At this stage, the risks associated with investing may still be present, but are generally considered to be less elevated than in earlier stages. The main risks include competition, difficulties in maintaining growth and the inability to reach the break-even point.
Investors participating in the late stage include venture capital funds, institutional investors, investment banks and hedge funds. These investors seek to achieve a return on their investment through the acquisition of stakes in the startup, which can be sold at a higher price in the event of a future acquisition or initial public offering.
At what stages can startups apply for crowdfunding?
Startups can generally apply for funding through crowdfunding during the early stages of the investment. Especially in the pre-seed and seed stage. In these phases, the startup may not have access to traditional investors such as venture capitalists or business angels and may seek to finance itself through crowdfunding. However, it is important to note that these are the more risky phases.
I hope this post has helped you better understand which part of our process startup investing falls into. Of course my advice is always to use a small percentage of the portfolio for these risky investments (1-3%).
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