🔎 Market Mysteries

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Venture capitalists tend to outperform the public stock market and many other asset classes because they invest in younger, faster-growing companies and capture more of their value creation. By the time a company IPOs, public investors may have missed out on 95% of the value growth. Twitter is an example of this. Twitter was founded in 2006 and grew to be worth $25 billion when it went public in 2013. In the decade since its value only grew by another 60%. In this case, it was the early investors who made the most profit.

There’s still plenty of money to make in the stock market. If you invested $1,000 in Amazon’s IPO in 1997, you would have an 850x return today. But companies are waiting longer to go public. Facebook waited until its valuation reached over $100 billion before its IPO. Early investors, such as Peter Thiel, were able to make incredible gains. Thiel invested $500,000 and walked away with $1 billion - a 2,000x return. If you invested in Facebook on its first day of going public, your shares would be worth about 4.5x today. Google launched in 1997 with $1 million in seed money. A couple of years later, it attracted $25 million from two venture capital firms, which acquired about 10% of the company each. Five years later, in 2004, Google’s IPO raised over $1.2 billion, netting the original investors almost $500 million, a 1,700% return.

It’s not easy to know which young companies will become unicorns, which are private startups with a valuation worth $1 billion or more. Some of the biggest unicorns right now are Tiktok-owner ByteDance ($140B), SpaceX ($127B), Shein ($100B), Stripe ($95B), and Canva ($40B). About 1% of startups reach unicorn status. However, they are trending and becoming increasingly more common. There are 30x more unicorns than there were ten years ago.

Just like investing in the stock market, you’re buying a share of ownership in the company. You’re giving the young company money to build out its team and product, and in return, you get equity. Your share of the company, your stock, gets more valuable as the company grows and gets more valuable.

Investment profits don’t come as quickly with startups. Startups are private companies, so there’s no market exchange with thousands of investors waiting to buy the share you want to offload. It takes time for a company to grow big enough to list on the stock market. When it does go public, called an Initial Public Offering (IPO), all the early private investors have an opportunity to sell their shares to public investors. Until then, you have to find your own buyer, just like with a home or other private asset. That means startup investors will usually earn their payouts when a big event happens, like when the startup gets acquired or it goes public. There are also opportunities for early investors to sell some of their ownership to new investors at each stage of funding.

It's not all just startup cash to get the idea off the ground. Companies keep bringing on new investors throughout their growth to IPO to accelerate their development. Venture capital, or startup investing, is broken into stages based on the company's maturity.

Many startups begin their earliest stages by bootstrapping, surviving from initial sales or the founders' savings. When startups look for outside investment, they first reach out to friends, family, or angel investors. That's typically called an Angel Round or Friends and Family Round. Angels will invest anywhere from $10,000 to $1 million. This is also known as pre-seed or seed funding, especially if professional startup investment funds called venture capitalists participate.

After seed funding, the startup can start Series funding. This process begins with Series A, when the startup has a business model to present a solid strategy to potential investors. Series B funding takes the business into the development stage, while Series C funding is for successful startups looking to scale up. The series continues until the company chooses to go public.

There a many ways startups can raise the money they need, from taking on debt to selling ownership shares. However, startups typically don't start selling individual shares until they reach Series funding. When companies are very young, valuing their company based on financial traction isn't easy. So they often award investors a contract for future ownership instead of issuing shares with a specific price.

The most common way to do this is through a SAFE note, a Simple Agreement for Future Equity. This contract converts into shares in the future for an agreed-upon value, usually after the startup is big enough to issue shares or get acquired. Investors will structure the SAFE note with a valuation cap, for instance, investing $1 million at a $10 million valuation cap. The valuation cap is intended to mark the minimum percentage ownership the investor will earn at the next priced round, when the SAFE note converts into actual shares. So the $1M investor locks in that minimum 10% ownership regardless of how much bigger the company gets. If the company gets valued at $20 million in its subsequent funding round, that $1M investor's SAFE note converts into shares worth 10% of that $20 million company, not just 5%.

Investing in private companies, especially young and unproven ones, comes with higher risks. There's much less information to base your decision upon and a higher risk of failure. Ninety percent of startups fail, and 10% will fail within the first year. When a startup fails, you can lose your entire investment.

Because of these heightened risks, regulators have restricted private company investing to only those with professional investing experience or plenty of money to lose. Accredited investors were the only ones able to invest like the pros on Shark Tank until recently.

In 2015, Congress passed Regulation CrowdFunding, allowing anyone to invest in startups through crowd-investing platforms like Republic, StartEngine, or Wefunder for as little as $100. These new investing platforms aren't based on donations like GoFundMe or Kickstarter. It's not charity. You buy equity in the company, making it an authentic investment experience where you benefit from its growth. Equity crowdfunding has exploded in popularity over the past few years as more startups seek funding outside the Silicon Valley elite.

As we’ve highlighted, startup investing isn’t easy. So focus your efforts on companies you can feel proud to support and truly believe in. Make sure you do your due diligence and research the company and founder. The more experienced the founder is, the better. Founders of a previously successful venture have a much higher chance of success with their next business.

Remember, never invest more than you can bear to lose. It can be really exciting to put your money behind the next wave of innovation, but changing the world isn’t easy. At the end of the day, the tradeoff comes with your appetite for risk.

Keep the risks in mind, as well as all the other Scoop investing principles of diversification, starting small, and strengthening your financial health first. If you have any questions, don't hesitate to ask.

As we always say, investing is for everyone, but it’s not always the right time for everyone. So don’t worry. If you can’t invest in us at this stage of our journey, we won’t be leaving you behind. We’re in this together.

You’re doing great,

The Scoop Team