My co-founder and I were the original investors in our first venture, ABUTEC. In fact, we were ultimately the only investors before we exited at an eight figure sum. How much did we risk? We both put in $34,500 to get the company launched and we ended up getting a line of credit for $100,000 before it got canceled in our first year because we were “too high risk”. We found another bank to support us for a year, but ended up with the same result. But, what I learned in this process is that investing in early stage startups can actually be more about the journey than the money? Let’s double click on that here.
Investing in early-stage startups can be a high-risk, high-reward proposition. On one hand, you have the opportunity to get in on the ground floor of a potentially hugely successful company, potentially reaping large financial rewards. On the other hand, the majority of startups fail, and investing in them can result in a complete loss of your investment.
As an experienced entrepreneur, I have seen the ups and downs of startup investing firsthand, and I would like to share my thoughts on the risk and reward of this type of investment.
The Risk of Investing in Early-Stage Startups
- High Failure Rate: The biggest risk associated with investing in early-stage startups is the high failure rate. According to research, about 90% of startups fail within the first five years. This means that there is a high likelihood that the company you invest in will not succeed, and you will lose your entire investment.
- Uncertainty: Startups are inherently uncertain. They are trying to solve problems that have not yet been solved, and there is no guarantee that their solution will be successful. This uncertainty means that there is no way to accurately predict the future success of a startup, and investing in one is inherently risky.
- Lack of Liquidity: Another risk associated with investing in startups is the lack of liquidity. Unlike publicly traded stocks, there is no established market for buying and selling startup equity. This means that if you need to sell your investment, it may take some time to find a buyer, and you may have to sell at a discount.
- Dilution: When a startup raises money, it typically does so by issuing new shares of stock. This dilutes the ownership of existing shareholders, including early investors. As a result, your ownership in the company may decrease over time, even if the company is successful. There are ways to combat this that we’ll discuss later.
- Valuation: Determining the value of a startup can be difficult, if not impossible. Most founders thing their idea, startup, or new venture is worth a gazillion dollars. It takes some time to get them to realize that product market fit matters.
The Reward of Investing in Early-Stage Startups
- Potential for High Returns: The biggest reward of investing in early-stage startups is the potential for high returns. If the company is successful, your investment could grow significantly in value, potentially leading to a large financial reward.
- Diversification: Investing in startups can also provide diversification for your investment portfolio. By spreading your investment across multiple startups, you can reduce the risk associated with investing in any one company.
- Access to Cutting-Edge Technology: Investing in early-stage startups can also give you access to cutting-edge technology and innovative business models. This can be exciting and rewarding in its own right, and it can also provide valuable insights that can help you in your own business ventures. The world is changing fast and staying close to the action is one way to give the investor an advantage.
- Opportunity to Play a Role: This is my personal favorite. Investing in early-stage startups can also give you the opportunity to play an active role in the company. You can provide mentorship and support to the founder, and you can help shape the direction of the company. This can be a rewarding experience and can also increase the chances of the company’s success.
- Networking Opportunities: Finally, investing in early-stage startups can also provide valuable networking opportunities. You will have the opportunity to connect with other successful entrepreneurs and investors, and you may be able to leverage these relationships to further your own business interests.
How to Minimize the Risk of Investing in Startups
I think the biggest determinant of success is a combination of the Founder, their team, and discovering what drives them to ensure success.
If you’re an investor looking to find a playground of fun in this ever changing world, early stage ventures may be the place to diversify your portfolio, have a ton of fun, and make what I call and “infinite impact” – which at the end may prove to us that the journey inside early stage ventures brings more joy than the money.
For more information on investing and early stage ventures, visit me online on all social platforms at AndySmithLife.
-Andy Smith “The BlackSmith”
Founding CEO of BlackSmith Ventures