6 Signs That You’re Ready To Invest In An Early-Stage Startup

There are plenty of success stories circulating the news of venture capital (VC) investors that have made substantial wealth through capital investments in early-stage startups. With the aid of technology and digital tools, entrepreneurs have become more connected with the right list of lucrative investors willing to fund their innovative business ventures.

And while there is no common definition that defines what a startup is, in recent years investors have found reasonable success and return on capital investment by placing their bets on early-stage companies, well before they have an initial product or service to offer the consumer market.

Yes, it’s possible to make a bit of money from startup investing, but there is also a different side to the story not many people tend to talk about.

For starters, it’s been found that around 90% of startups end up failing, with approximately 10% of startups failing within the first year. Looking at that in perspective, against the number of startups that don’t make it past their first year, first-time startups only have an 18% success rate from founding to launching their first product or service.

There is a certain level of risk involved when investing in any startup, especially if the investment carries some form of monetary value, which in most cases it does.

For the investors that do end up taking the risk to invest in early-stage startups, the financial returns of startup investing tend to be higher than investing in publicly listed equities. According to historical data by Cambridge Associates, over 20 years, venture capital return can be 11% annually, whereas with equities annual return is substantially lower at 7.5%.

Although the above-mentioned only takes into consideration the United States, the broader appeal shows a growing number of investors frequently learning about emerging trends and technologies entrepreneurs are using to resolve some of society’s biggest problems.

Investors generally look at several considerations before making their final judgment on whether investing in an early-stage startup will be worth their time and money.

So, if you’re ready to diversify your investment portfolio, and potentially broaden your growth strategies, here's a look at the six signs that you may be ready to invest in an early-stage startup.

You’ve done your homework

Investing in an early-stage startup is a lot like putting your money in the ground and hoping something grows from it. This is a bold and risky move, and there’s not always a clear sign of whether this was the right decision or not.

Before making any bold or risky moves, especially if it’s a financial decision, it’s better to look at some of the basic considerations well before calling your final shots.

If you ask any investor, whether it’s someone who invests in startups or equities, generally they have done some research about the company or equity they’re looking to invest in.

There are several questions you should be able to answer, without hesitation.

• Does the product or service offer a viable solution to the current market climate?
• Does the management team have a successful track record of working on projects and services related to their business?
• What is their motivation, and how will the team or startup be able to bring this to life?
• What are the potential market considerations that the team has not yet considered?
• Can there be improvements throughout their initial startup process that the team has already recognized?
• What is the lifetime value of the product or service?
• What will my capital be used for, and will I be able to make suggestions?
• Is there already a healthy cash flow in the business?
• In the long term, what will my return on investment be?

There’s quite a long list of things you can ask before opening your checkbook. For any investor, it’s important to take into account the many obstacles a new business will have to overcome throughout its first couple of years. Additionally, how will the business overcome these challenges, and will this direction help them grow?

If you can answer some of these questions without having to hesitate or reconsider your answer, there’s a chance you may have already been ready to invest in an early-stage startup.

You have a diversified portfolio

Another key factor that could help you decide on whether you’re ready to invest in an early-stage startup is to see whether you have a diversified portfolio.

As an investor, you’re already well aware of the potential threat macroeconomic changes can have on your portfolio, especially if you only invest in specific markets, companies, or securities.

To ensure you have the right arsenal that can help you ride out the changing economic cycle, such as that we’re currently experiencing, it’s imperative that you already have a diversified range of assets that can help you overcome challenging market conditions.

Investing in a startup of any size requires a bit of leverage from your side as well. What this means is that when you place your cash in the capable hands of a team building new services or products, your portfolio should be prepared to carry that burden for the first couple of months or years.

It’s important to take the time to learn whether you have invested enough across multiple assets, equities and sectors. This will give you a clear indication of whether you need to improve your portfolio diversification strategy, or whether you have enough leverage to start investing in startup companies.

You have a strategy to mitigate the risks

With a record of 5.4 million new startup registrations filed in the United States in 2021 according to the Census Bureau’s Business Formation Statistics, opening yourself to such major risks requires a plan and foolproof strategy that can help you mitigate the involved risks.

As more and more so-called entrepreneurs and first-time business owners enter the market, it’s become increasingly challenging for investors to find the best and most viable startups that are set to experience potential growth in the coming years.

As a seasoned investor who’s constantly exposing themselves to economic instruments, it’s important that you already have a strategy or plan at hand when things start to go south.

For the sake of investing in an early-stage startup, it’s important that you consider how much of your portfolio will be exposed, and what your potential withdrawal strategy will be. Though it’s not set in stone that the chosen startup will fail, it’s always a lot better to be prepared than to run into sudden financial downturns that can come at any given time.

You have analyzed the startup opportunity

There might come a time when you have analyzed the startup opportunity to consider the risks and rewards that may be involved.

Seeing as some startups are still in the early stages of their growth cycle, you may need to take some additional caution to analyze the Five Ms of Startup Investment.

Management Team

This includes the team members involved in the company’s management structure such as the founders. Consider how capable these founders are of running a business, and what their growth strategy might be. You can also consider their level of experience and how much potential they have in the near term.

Model

Secondly is the business or revenue model through which the startup is looking to operate. This is a time when you as a potential investor can analyze the different structures they have in place that will help them acquire the necessary resources that will help them grow.

Market

For any business, big or small, there needs to be a market or consumer audience that requires the services or products offered by the startup. If the market is already too saturated, or over-competitive, consider how the startup will navigate these challenges.

Money

What is the startup planning to do with the money they obtain from investors? Further considerations can be how much money is needed for the startup to operate successfully, and how will this create value.

Momentum

Finally, you can look at the momentum or pace the company is expected to grow. If there is already a high demand for their services or products, this could be a positive attribute for the startup's initial growth phase.

These five key factors are important for investors to consider, as it helps to differentiate between a startup ready to drive meaningful change or even fail due to internal problems.

You meet basic SEC requirements

It’s impossible to make a tangible purchase without the necessary funds, so why pour your money into an investment if you’re not in a financial position to do so?

The level at which you invest can come at a different price tag, and this could see you spending anything from $100 to even $100,000 on a startup investment, the amount you end up investing all depends on your financial position.

By now you might be well aware of the regulations tied to any form of investment you make, and for novice startup investors you will need to make sure you are aware of the maximum amounts you can invest in crowdfunding or startup ventures.

According to the guidelines of the Securities and Exchange Commission (SEC):

• Investors with an annual income or net worth of $107,000 can invest greater than $2,200. Additionally, investors might also be able to invest 5% of the lesser of their annual income or net worth.
• Investors with an annual income or net worth equal to or more than $107,000, are able to invest up to 10% of their annual income or net worth. Whichever is less, the total amount invested cannot be more than $107,000.
• These regulations apply to any given 12-month period and should be routinely reviewed.

The guidelines by the SEC ensure that investors are capable of managing their finances in accordance with their financial position and that those who look to partake in crowdfunding ventures have the necessary capital to do so.

You’re confident in your decision

After much consideration and consolidation, you have reached a final decision on whether you are ready to invest in an early-stage startup. Whatever you decide, it's important that you feel confident in your decision and follow through with it.

Seeing as there is a higher level of risk involved when investing in an early-stage startup, as an investor you should ensure you have an investment strategy to help navigate the near-term and long-term goals of your investment decision.

Perhaps you’re looking to pass on the opportunity to invest, for now at least, this should come after careful consideration of all business and investment-related aspects.

There’s no right or wrong way you can go about this, as the final decision lies within the confidence you have for the startup, and its potential to make a difference in our society.

To finish off

As a potential investor, you will need to answer some hard-hitting questions that may leave you doubting your decision in the first place. With more and more entrepreneurs entering the market, it’s becoming increasingly hard to source out the winners from the losers.

To find the winners, consider how much time you’ve vested in researching the company and the team. Whether your portfolio is diversified enough, and what your strategy is to help mitigate major risks or potential losses. Then, consider whether you’ve analyzed the startup opportunity and if your financial position allows you to invest in an early-stage startup.

When you manage to tick all the boxes, and you’re confident not only in the product or service the startup looks to offer their market, but you also feel confident in yourself, then you are set to invest in a startup.