A 2008 study by entrepreneurship scholar Michael Song proved that the longer a new start-up stays in business, the higher its likelihood for eventual success.
That’s great, but when a company is just getting started, how can an investor possibly predict which start-ups will be able to survive and which will quickly fold?
Well, a new study from Redpoint Ventures has uncovered a surprisingly simple method for predicting a start-up’s staying power.
If you use this trick, it should improve your chances of investing in a “survivor” by more than 63%.
Read on to learn more...
Why Start-ups Fail
You know the old joke, “Why did the chicken cross the road?”... right?
Well, I’ve got another one for you.
Why did the start-up go out of business?
Because it ran out of money.
As trite as that may sound, it’s true. At the end of the day, companies shut down because they don’t have enough cash left to pay their bills.
If a company can keep the lights on, it can live to fight another day and potentially find the right strategy to succeed.
So how does a company keep its coffers full?
How Start-ups Stay Flush
There are two ways a company can keep cash in the bank...
One way is by generating revenue.
But for a start-up — one that typically suffers losses for its first 1 to 2 years in business — that’s not a likely path.
The other — often much more reliable — way is through fundraising.
So when you’re evaluating an early-stage company, it would be helpful if you had a way to forecast the company’s ability to raise money.
Well, as it turns out, you can...
Tomasz Tunguz of Red Point Ventures recently published a study.
His study compared two types of companies:
- Companies that raised both a first round AND a second round of financing — known as a Series Seed and a Series A, respectively.
- Companies that could only raise a first round.
His study concluded that if a company raised its initial round of funding from a Venture Capital fund, then it had a 54% chance of raising an additional round of funding. Companies that did not have a Venture Capital fund involved in their seed round only had a 33% chance.
Meaning, start-ups that were initially backed by deep-pocketed venture funds were 63.6% more likely to be able to raise more money down the road.
In other words, you can stack the odds in your favor by investing in a start-up that was backed by a venture fund and not just by individual angel investors.
How are the two different?
Well, a venture fund generally has a lot more money than an individual investor. The venture fund has the capacity to invest in multiple rounds of funding for a single company.
Angel investors are regular guys like you or me. They generally only have the wherewithal to invest in the first round of funding and that’s it.
Be a Follower
This is another reason why we’re such big advocates of our “Thou Shalt Be a Follower” commandment in our 10 Crowd Commandments report.
Not only does that commandment help you leverage the research the VC has already performed on the company...
But you also get the added benefit of the VC’s bank account as well.
A bank account that can keep a start-up afloat while it figures its business out.
So, the next time you’re looking at a seed-stage investment on one of the equity crowdfunding platforms, pay close attention to who your co-investors are.
It might make all the difference when it’s time for the start-up to put more cash in its coffers.