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Why is it Important to Invest in Early Stage Startups?

Investment is important to the founder of an early-stage startup because it pays for the team, the infrastructure, and the prototypes that are needed for them to grow. To a business angel, early-stage investment is important because it allows them to obtain a significant equity stake at a low valuation. This gives them the ability to influence the direction of the startup and by extension the outcome of their investment.

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Innovation

Investment in early-stage startups is also of strategic importance at a macroeconomic level, especially when advanced technology is involved. That is because technological innovation is a key driver for productivity gains and GDP growth across the global economy.

Academic bodies such as the Journal of Innovation and Entrepreneurship have established a clear empirical link between levels of innovation in a country and its long-term economic growth. They also underline the importance of policies that encourage investment in technological innovation. Nurturing early-stage startups is now an important component of the digital strategies pursued by organizations such as the European Union (EU). As a result, early-stage startups are being offered new forms of government-sponsored support such as the EU’s Startup Europe.

According to the Harvard Business Review, digital evolution is closely linked to economic resilience in the face of shocks such as the recent Covid 19 pandemic. It provides a path to higher economic growth, which delivers better revenues for business and rising tax receipts for the government. Investment in early-stage technology startups is where this whole growth story begins.

 

The startup challenge

A startup is a young company founded by entrepreneurs who seek to develop a unique product or service and bring it to market in a validated and scalable way. A startup that hasn’t secured investment yet is sometimes referred to as being at the pre-seed stage. The main task of an early-stage startup, therefore, is to persuade potential seed investors that their concept is valid and has the potential to deliver a substantial return on investment (ROI) in an acceptable timeframe. 

Because the development of a startup’s product or service often requires significant sums of money, founders need to make a convincing argument to investors that what they intend to sell is genuinely new or a significant improvement on what already exists in the marketplace. Because there is normally limited evidence of market traction at the early stage in the life of a startup, an investment of this sort is inherently risky. Founders, therefore, need to design and present their startup in a way that minimises the perception of risk.

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Early-stage investors

Potential investors in early-stage startups include family, friends, incubators, venture funds, and often the founders themselves. The other main category is angel investors, who are generally high-net-worth individuals who are willing to accommodate higher risks in return for an equity stake in small businesses. They differ from venture funds in that they usually invest their own money. A round of seed funding commonly varies from $10,000 up to $2 million, depending on how much money is needed to get the business off the ground and delivering proof of concept in the marketplace.

 

Rewards

There is usually a personal as well as a financial dimension to angel investing. Many business angels find fulfillment in passing on their knowledge and advice to entrepreneurs who are starting out on their journey. Equally, founders benefit from a mentor’s support, which can help them gain confidence in both themselves and the project.  

Clearly, however, the principal ambition of every business angel is to generate an exponential ROI as a reward for the elevated risk they are taking with their capital. Having committed time and money, their priority, therefore, is to establish whether the startup will deliver on its promise in the real world. 

 

Validation

Trying out new and better ways of doing things with technology is frequently disruptive, expensive, and risky, which can act as a deterrent, especially to an established business. New technology doesn’t always work as expected or outperform its competitors sufficiently to drive growth. This is why qualified startups such as those selected by PitchDrive are a good place for business angels to start. Here they can find innovative startups that have already been vetted. This accelerates the journey to validation in the marketplace. 

In return for their early-stage seed investment, the business angel receives crucial evidence about whether the startup’s product or service addresses a pressing need in the marketplace that people will pay for insufficient numbers. Their investment enables the startup’s sales dynamics to be tested to see if they can support efficient growth and whether the right team is in place to execute the growth plan. Typically it also funds important tasks such as product development, market research, building a customer base, and establishing a strong cash flow.

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Conclusion

Investment in early-stage startups is important because it finances the innovative technology businesses and industry sectors of the future, which are more likely to deliver high growth. While seed investments in early-stage startups are inherently risky, especially in sectors with high barriers to entry, the ROI can also be exponentially high. This is partly because any equity stake that the business angel acquires is likely to be at a low valuation and will provide them with a degree of control over their investment that would not be possible with a later-stage business.

 

At Pitchdrive, we help investors grow their portfolio. Based on our years of research and expertise, we’ve hacked the qualification process. We can manage your personal startup inflow and take over the qualification, valuation, legal and operational work for you. From sourcing and qualifying to tracking portfolios, everything is managed from a single app. 

Learn more about how we can help grow your portfolio.

Written by Peter Jinks

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