Risk vs. Reward: The Realities of Startup Investing

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Late-Stage vs. Early-Stage Investing

I've been thinking a lot about the challenges I've been facing while running a syndicate lately. Many LPs are eager to join different syndicates, chasing tier-one investors, later-stage deals, and those impressive partnerships and traction metrics. But here's the reality: those later-stage deals, while seemingly safer, often don't yield the greatest returns.

The Power of Early-Stage Investing

Let me break it down with a concrete example. Imagine a startup at the pre-seed stage with a $10 million valuation. You invest $100,000, getting a 1% equity stake.

Fast forward a few years, and the company grows to a $200 million valuation at its Series B. Assuming a typical dilution of around 50% through successive rounds (common for early-stage investments), your stake reduces to 0.5%.

Now, let’s say the same company eventually becomes a unicorn and sells for $1 billion. Your initial $100,000 investment is now worth $5 million (0.5% of $1 billion). This is a 50x return on your original investment.

Now, consider the same company at the Series B stage, now valued at $200 million. You invest $100,000 again, but this time, you get only a 0.05% equity stake. If the company grows to a $1 billion valuation, your investment grows 5x, making your stake worth $500,000 (0.05% of $1 billion). Assuming a typical dilution of 20% at later stages, your stake reduces to 0.04%, and your return would be $400,000.

Balancing Risk and Reward

While investing at the Series B stage seems safer due to proven traction and tier-one investors, the return potential is significantly lower compared to getting in early at the pre-seed stage. Plus, early investments, though riskier, tend to result in more favorable dilution rates over time.

Syndicates often face the challenge of balancing these dynamics. LPs crave the security and validation that comes with later-stage deals backed by tier-one investors, but they must understand that higher returns typically come from taking on more risk in the early stages. If there is one thing you want to take away after reading this I would say diversification is key. Find a number that you feel comfortable investing and aren’t afraid to lose. But if you find the companies early on, the reward is far greater with the risk.

Resources

If you want to learn more about Angel Investing read last week’s post where I dive into my journey of how I was able to begin investing in start-ups!

?? That’s all for now friends! See you next week.

Next week I am going to dive into syndicate and fund returns and why sometimes it is important to take the risk because the reward can be far greater!

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Disclaimer: The Cap Table DOES NOT provide financial advice. All content is for informational purposes only. The Cal Table is not a registered investment, legal, or tax advisor or a broker/dealer.