Opportunities and risks of early-stage investments
Investing in early-stage is an opportunity to take a stake in the next big thing. Early-stage companies offer high potential profits. Research on early-stage investments by British business angels found that 9% of the companies generated more than 10-30 times the capital invested. Although more than 56% of the companies failed, the average return on early-stage investments outperformed the returns on listed shares over the period 1998-2008.
That being said, investments in early-stage companies are risky. If the company fails, which is common, you will most likely lose your invested capital. The company may also grow but without generating any substantial profit for its investors. Finally, the company may not grow as expected and may have to raise more money at a lower valuation.
It is important to note that 1) even successful early-stage companies rarely distribute any dividends since they need their capital for growth and 2) finding a buyer at the time you want to sell your share may be difficult. For more information about risks, please refer to our risk warning.
In order to reduce your risks, you should invest small amounts in many companies rather than a large amount in just one or two companies. If you invest in many companies, you are more likely to make a profit on your investment portfolio even if some of your investments fail.
You can also reduce your risks by doing some research about the businesses before you invest. Want to learn more? Read on.
Get to know the company
Before you invest, you should try to get a full picture of the company. All investment offerings on the platform include sections about the company’s product or service, market, risks, team and financials. We have verified all factual statements in the offerings, based on references provided by the companies. If a company for instance writes that the global market for medical devices is estimated to grow by 20% per year during a five year period, we will require a reference supporting that statement. The reference could be an article in a news paper, a report or an interview with an industry professional and similar sources.
In addition to the information provided by the company in its investment offering, you can
• Look at the LinkedIn profiles of the team
• Google the company and its market
• Ask questions to the company
• Discuss the investment offerings with other investors
• Read comments by other investors on the platform
In making the investment decision, you should evaluate the potential and risks of the company. Some factors you could think about are:
• Does the product or service solve a problem for its users? Will the intended users be willing to pay for solving this problem?
• Is the product or service better or different than other solutions on the market?
• Does the company have any advantages such as know-how, distribution agreements, relationships or patents that are difficult for competitors to copy?
• Will the market demand be sufficiently large to build a profitable company in the long term?
• Will the company be able to reach out to its intended customers and sell its product? How will the product or service be distributed to the end consumer?
• Does the team have the capabilities and experience to realize its plans? Will the team be able to recruit any missing competence?
• Has the team invested time or money in the company and does the team own shares in the company? If that is the case, the team will most likely be more committed to build the company.
• Has the company made any substantial accomplishments to date? Developed a prototype, established valuable relationships, made some pre-sales or received any awards or similar?
• Is the company’s plans reasonable and will the capital the company raise cover the costs to reach a significant milestone? If so, it is more likely that the company will be able to raise follow-on financing at a higher valuation.
• Will the company be able to earn money? How many units does the company need to sell to cover its costs?
• Would other companies be willing to buy the company in the future? The most likely way to make a profit on your investment is if the company is bought by another company.
Keeping these questions in mind may help you to decide if you believe in the company and if you want to invest at the proposed valuation. If a company for instance have a very bright outlook but the valuation of H&M, it is probably not worth investing in. On the other hand, if a company is very early-stage and have not made any key accomplishments to date, and offers its shares a low valuation, it might be worth investing in although the risks are high. The questions you will need to ask is if the company’s valuation is reasonable given its stage, potential and risks.
It is important to notice that this guide only covers some examples of questions you might want to look into.