The main difference between venture and traditional investments lies in the potential of the project. In case a risky venture fund or individual finds the right business model to scale, it can become a major player in this particular field, and investors can expect returns that are sometimes thousands of times higher compared to their initial investment.
Talking about ordinary investments, the investor expects a stable, but not super-high income, however, the risks of such an enterprise are usually much lower. As a rule, we are talking about innovative startups representing technology industries such as software development, cloud computing, AI, MedTech, and others.
The venture is the riskiest type of investment: according to statistics, 75% of startups do not justify the investment. In 30-40% of cases, the project goes bankrupt, and investors lose all the funds invested in it. In most cases, the result is worse than planned. However, if all of a sudden the company "shoots", the income from such an investment can be mind-blowing.
Venture Projects Explained
A venture startup is a new business, but it has to include explosive potential. For instance, in case someone opens a new cafe or hair salon, this is also a new young business, but it will not be considered a venture. In order to be considered as a venture startup, the following criteria have to be met:Innovative Idea. The project offers something new that is not yet on the market. Ideally, it has to be some kind of breakthrough technology that can contribute to the future. For example, one of our portfolio startups EYWA intends to make Decentralized Finance (DeFi) easy, convenient, and understandable even for beginners. In order to make it happen, they are trying to simplify the user experience when interacting with the DeFi sector as much as possible.
Technology. The product has to fit into the new technological paradigm. Since the first industrial revolution in the 18th century, humanity has passed through five successive technological cycles. Now we are at the beginning of the sixth, driven by: bio- and nanotechnologies, new ways of absorbing energy, and AI.
Among other things, technological products have high added value, which determines the high marginality business - that is, high profits at low costs. Previously we used to see the two most tech-related sectors in the S&P500: IT and Healthcare. They were the locomotive of the index in the last decade and they achieved more than 40% of its capitalization.
Scalability. Such companies are capable of active expansion, capturing new markets and regions worldwide. Getting new customers doesn’t have to be associated with additional costs. This provides the business with exponential revenue. An ideal scenario is to have a fast-growing social network that has no physical connection and is able to reach a global multilingual audience.
Thus, venture capital brings together technology carriers and investors. It is venture capital that decides the problem of financing startups, and thanks to it, we saw companies like Google and Facebook.
Development milestones and stages of startup financing
The development of a venture project is in many ways similar to the life and development of a living entity: conception, birth, growth, development, and flourishing.
Some companies take longer to get to this way, some less, some may get lost along the way, not achieving the flourishing stage. The main key stages of life for any venture business will be approximately the same, and the problems will be similar. The main stages stand as follows:
1. Seed
A startup is the realization of a hypothesis. An entrepreneur who has such an idea begins to form a team, prepare a business plan, analyze demand, and look for the target audience.
Ideally, a startup and its team talk about its product, learn and analyze the reaction, conduct surveys, reach startup accelerators, and launch crowdfunding projects to check whether people need a product and whether they are ready to pay for it. Based on these results, new edits and improvements are reflected in the plan and roadmap. The idea might be “polished” and the whole concept might be changed completely.
- Main task: the team must create a commercial proposal and a basic product model, albeit with a minimal set of functions, but working to prove your idea to potential investors not only in words but also in deeds.
- Funding: at this stage, the young company relies on its own funds, relatives, friends, crowdfunding, and grants. The company actively seeks and sometimes finds business angels. A great example is Tom Ahlberg who believed and invested in Amazon at its early stage. Relatives usually invest from $10,000 to $50,000, angels, on average, from $100,000 to $1M.
💡 Investing during the Seed stage is the riskiest type of venture investment.
2. Startup
At this stage a new project was born, officially registered, and the product is finally entering the market.
- Main task: the formation of a client base, search or creation of your own niches, deployment of a marketing strategy, and aggressive brand promotion. The startup team is testing, optimizing, and working on its product and brand improvement. The company is not yet profitable, but the first results of the work are already visible.
- Funding: at this stage, the startup also relies mainly on funds of business angels who can invest from $100,000 to $1M, depending on their capabilities and the size of the enterprise.
💡 But it’s too early to celebrate! The project has not yet left “Death Valley”. This is a critical period when the company is already operating and spending funds, but there is no profit yet. The chance to lose everything for investors is slightly less compared to the previous “Seed” stage: the probability of failure is no longer 99.7%, but ranges from 95 to 99%.
3. Early growth and Expansion
If a startup has successfully passed "Death Valley", then revenues and the number of customers both begin to grow. New opportunities are on the way, however, new challenges follow. Usually, during this stage a firm ceases to be a group of cheerful like-minded people who needed one pizza for everyone, the staff is expanding and it becomes necessary to run more effective management, accounting system, and new business plan. This is where the company’s corporate culture begins.
- Main task: expansion and scaling: new markets, new distribution channels, attracting new customers, and retaining old ones. A firm adds additional products or services to its package, and the stronger and more successful it becomes, the larger and more serious it starts to be. Here’s where the most serious work begins.
- Funding: at this stage comes the time of venture capital funds, which can offer investments from $10M, and sometimes up to $100M. The amount depends on investors’ expectations related to a project.
4. Exit
Startup owners start thinking about exiting when the project reaches maturity. Sales and profits have to be solid, however, competition remains fierce. After a period of time, indicators and metrics may begin to fall - this is quite a natural process. At this point, it is worth thinking about exiting the business, claiming dividends, and doing something new or expanding it further.
There are several exit options:
- Sale of the company to a strategic buyer following the example of YouTube, WhatsApp, or Instagram and receiving excess profits;
- An exchange listing implies that your company is being openly traded stock and trying to become a Unicorn like Snapchat, Twitter, or Airbnb;
- Continue to develop business and receive dividends without IPO or entering a stock market in any way
Advantages, Disadvantages, and Risks of Venture
The main advantage of venture capital investment is the possibility of extremely high profitability. However, this is usually a long journey, as the average time an investor stays in a project is about five years.
The advantages of venture capital startups:
- Huge growth potential
- Quick adaptation to market requirements
- The flexibility of management and internal communications, the efficiency of management decisions
- Creative freedom is an opportunity for a person to express themselves and realize their ideas;
- No significant funding is required in the pre-launch phase (and no investment is needed to maintain a large fleet of equipment).
The disadvantages of venture capital startups:
- High risk. According to statistics, 75% of venture projects are not able to revert funds to their investors. 20% of startups fail within the first year, 30% fail within two, and 50% of them fail within the next five years. In venture capital investment, it is not enough to study company reporting for several years and make a forecast for several years forward.
💡 That is why, in the early stages, the most successful venture capital investors come from former entrepreneurs.
- Long wait. Some projects take off quickly, but some enterprises need time to "promotion" (sometimes it takes a lot).
- Fraud. Sometimes financial pyramids are hidden under venture projects. In this case, there is a danger of losing all the invested funds.
💡That’s why Afford.Capital runs its own security check for every startup.
A large amount of work. Finding a good project is difficult because all early startups are not public, and it is difficult to compare a few similar startups with each other. For a private investor, this is the second full-time independent work, and it is difficult to combine it with another business or job.
💡 Here at Afford.Capital we carefully vet promising startups for you.
Entry threshold. For instance, in order to participate in a private round of one of our portfolio startups Yalla!Market, you needed to have at least $50,000. Our fund always strives to make it easier for retail investors to invest in future Unicorns, so our entry thresholds in different allocations are decreased drastically exclusively for our investors.
Top Reasons Startups Fail
The Mechanics of Vetting Startups at Afford.Capital
Before Afford.Capital offers its investors a startup to invest in, it undergoes 3-step verification:
1. A unique scoring system
The project team fills in an application that goes through a scoring system. Then, a smart algorithm analyses historical data, trends, search queries on the Internet, and other 220+ parameters.
2. We run a fundamental analysis
The team uses the research experience. In general, our team analyzed over 6,000 startups and invented 220+ metrics of the scoring model to find the projects worthy of attention.
3. Security check
We filter out scams, pyramids, and projects that have bad reputations.
