Whether they want to change the world or simply make their business vision a reality, startup founders dream of giving society something it needs but hasn’t created yet—and doing it at scale.
For the less industrious, startups also have another appeal—eye-popping valuations that hopefully lead to an initial public offering (IPO) with an astronomical return on investment.
Startup Company: What Is It?
Startups are young companies founded to develop a unique product or service, bring it to market and make it irresistible and irreplaceable for customers.
Startups are rooted in innovation, addressing the deficiencies of existing products or creating entirely new categories of goods and services, thereby disrupting entrenched ways of thinking and doing business for entire industries. That’s why many startups are known within their respective industries as “disruptors.”
You may be most familiar with startups in Big Tech—think Facebook, Amazon, Apple, Netflix, Google, collectively known as FAANG stocks—but even companies like WeWork, Peloton and Beyond Meat are considered startups.
How Does a Startup Work?
On a high level, a startup works like any other company. A group of employees work together to create a product that customers will buy. What distinguishes a startup from other businesses, though, is the way a startup goes about doing that.
Regular companies duplicate what’s been done before. A prospective restaurant owner may franchise an existing restaurant. That is, they work from an existing template of how a business should work. A startup, on the other hand, aims to create an entirely new template. In the food industry, that may mean offering meal kits, like Blue Apron or Dinnerly, to provide the same thing as restaurants—a meal prepared by a chef—but with convenience and choice that sit-down places can’t match. In turn, this delivers a scale individual restaurants can’t touch: tens of millions of potential customers, instead of thousands.
This also points to another key factor that distinguishes startups from other companies: speed and growth. Startups aim to build on ideas very quickly. They often do this through a process called iteration in which they continuously improve products through feedback and usage data. Oftentimes, a startup will begin with a basic skeleton of a product called a minimal viable product (MVP) that it will test and revise until it’s ready to go to market.
While they’re enhancing their products, startups are also generally looking to rapidly expand their customer bases. This helps them establish increasingly larger market shares, which in turn lets them raise more money that then lets them grow their products and audience even more.
All of this rapid growth and innovation is typically, implicitly or explicitly, in the service of an ultimate goal: going public. When a company opens itself up to public investment, it creates an opportunity for early investors to cash out and reap their rewards, a concept in startup parlance that is known as an “exit.”
How Are Startups Funded?
Startups generally raise money via several rounds of funding:
- There’s a preliminary round known as bootstrapping, when the founders, their friends and family invest in the business.
- After that comes seed funding from so-called “angel investors,” high-net-worth individuals who invest in early stage companies.
- Next, there are Series A, B, C and D funding rounds, primarily led by venture capital firms, which invest tens to hundreds of millions of dollars into companies.
- Finally, a startup may decide to become a public company and open itself up to outside money via an IPO, an acquisition by a special purpose acquisition company (SPAC) or a direct listing on a stock exchange. Anyone can invest in a public company, and the startup founders and early backers can sell their stakes to realize a big return on investment.
It’s worth noting that the initial stages of startup funding are limited to those with especially large pockets, people called accredited investors, because the Securities Exchange Commission (SEC) believes that their high incomes and net worths help shield them from potential loss.
While everyone wants the more than 200,000% return Peter Thiel saw on his investment into a little startup called Facebook, the vast majority—about 90%—of startups fail, according to a report authored by UC Berkeley and Stanford researchers. This means early stage investors have a very real possibility of seeing 0% returns on their investment.
How Do Startups Succeed?
While many startups will ultimately fail, not all do. For a startup to succeed, many stars must align and crucial questions be answered.
- Is the team obsessively passionate about their idea? It’s all in the execution. Even an outstanding concept can fail to engage its audience if the team isn’t ready to do everything to support it.
- Do the founders have domain expertise? The founders should know everything about the space in which they operate.
- Are they willing to put in the time? Early startup employees often have intense work schedules. A 2018 survey by MetLife and the U.S. Chamber of Commerce found that startup owners log 14-plus-hour workdays. If a team isn’t willing to devote most of their waking hours to an idea, it may struggle to thrive.
- Why this idea and why now? Is this a new idea, and if so, why haven’t people tried it before? If it isn’t, what makes the startup’s team uniquely able to crack the code?
- How big is the market? The size of a startup’s market defines the scale of its opportunity. Companies that obsess over niche technology may outcompete their rivals, but to what end? Too small of markets may lead to financials that aren’t large enough to survive.
If a startup is able to answer all of these questions, it may stand a shot at becoming part of the 10% of early-stage companies to survive.
How to Invest in Startups
Unfortunately, startup investing isn’t widely available to the masses.
To gain access to the most desirable early stage startups, or the venture capital funds that have the best shot at Thiel-level returns, you must be an accredited investor. In simple terms, this means you have an annual income of at least $200,000 or a net worth, not including your primary residence, of at least $1 million. You also may be able to claim accredited investor status, regardless of income or net worth, if you work as a registered investment adviser.
If you don’t fit any of those bills, you aren’t out of options, though. Crowdfunding sites like WeFunder or SeedInvest allow anyone to put down a small sum in exchange for a piece of a startup. SeedInvest boasts pre-vetted opportunities and an investment minimum of $500—50 times lower than the typical check expected from accredited investors looking to get into the startup investing game.