Starting a business of any kind typically takes capital. While you might be able to get by on your own (or with the help of friends and family) in the very early phases of your startup, you may soon reach a point where you need additional funding. Raising capital from early-stage investors is one possible solution.
Here’s a closer look at how this type of equity financing works, who offers it, and the pros and cons of bringing in an early-stage investor.
Key Points
• Early-stage investors provide essential capital to startups during their research or development phase in exchange for equity.
• Angel investors and venture capitalists are primary early-stage investors, differing in investment strategies and risk tolerance.
• High risk is inherent in early-stage investing, but it offers potential high rewards if the startup succeeds.
• Equity financing from early-stage investors requires no repayment but typically involves relinquishing some control and ownership.
• Alternative funding options in the early stages of business development may include small business loans, crowdfunding, and grants if equity financing is unsuitable.
What Is the Early Stage of a Business?
The term early-stage is often used to describe a business in the pre-growth stage. Typically, the company has identified a product and its market and prepared a business plan, but still has limited (or no) revenue, sales, or market share.
The early stage of a business is generally characterized by activities such as research and development, marketing research, and product development. It’s also sometimes referred to as the “seed” or startup phase of a business.
How Does Early-Stage Investing Work?
Although there are many types of small business loans for established businesses, there are fewer options for a startup in the early stage because the business hasn’t proven itself yet.
This is where early-stage investors come in. If small business loans or grants don’t pan out, an early-stage investor could help. Early-stage investors are people or groups who provide startups with funding for their projects, typically when these projects are just beginning and are still in the market research or development stages.
Early-stage investors typically provide enough seed capital to get a startup off the ground and to the point where they are either self-sufficient and profitable, or in a position where they have proven their business concept and can move onto another stage of funding (such as series A or series B funding).
Early-stage investors are willing to provide the funding (and take on high risks) in exchange for equity in the business. Depending on the agreement, the investor may also take a seat on the board of directors or otherwise be involved in decision-making for the company.
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Notable Early-Stage Investors
Early-stage investors include angel investors and venture capitals. Here’s a look at some of the top current early-stage investors.
Arch Venture Partners
With a focus on healthcare and life science, Arch Venture Partners recently announced an almost $3 billion fund for early stage biotech companies.
GGV
Having invested primarily in tech innovators (such as Hootsuite and Affirm) for the past 25 years, GGV has made 866 investments and raised close to $8 billion across their various funds.
Lightspeed Venture Partners
Having invested in such businesses as Snapchat and Elementor, Lightspeed Venture Partners is known for funding tech innovators. Over the last quarter-century, they have backed about 400 businesses.
Menlo Ventures
Uber and Siri are among the household-name businesses to receive funding from Menlo Ventures. In his 265 investments, this early-stage financing firm tends to go where tech and robotic innovation is happening.
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Pros and Cons of Being an Early-Stage Investor
Investing in early-stage companies comes with risks but also potentially high rewards. Here’s a look at some of the benefits and drawbacks.
Pros
• If the early-stage business is successful, you could end up seeing a significant return on your investment.
• Investing in a startup is a way to support entrepreneurship and help promote innovation.
• Investing in an early-stage company can be an exciting and rewarding experience, since startups often have passionate teams that are willing to work hard to make their business succeed.
Cons
• There’s a relatively high risk of failure. Many startups don’t make it, so you could end up losing your investment.
• Being an early investor requires work: You may have to help the company with strategic decisions or provide mentorship.
• New startups typically require a lot of funding, so you may have to invest a significant amount of money upfront.
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Pros and Cons of Early-Stage Investors for a Business
Here are some upsides and downsides to consider:
| Pros | Cons |
|---|---|
| Can provide a much-needed injection of capital | Will need to come up with a company valuation |
| Money does not have to be repaid | Requires giving up some equity and control of business |
| Investors can provide guidance and valuable connections | Can be difficult to get |
You can also look at these perspectives as follows:
Pros
• Early-stage investors can provide the funding you need to get your company to the next level.
• Equity financing generally does not come with any fixed repayment requirements. (There is an expectation of an investment return, but the return is generally expected five to 10 years in the future.)
• Early-stage investors can often provide valuable business expertise and connections that can help you build and grow your business.
Cons
• Bringing in an early-stage investor typically requires a valuation of your company, which can be difficult if you don’t yet have steady revenue streams or assets.
• Early stage equity financing involves giving up some ownership of (and control over) your business. In fact, you could end up owning a small percentage of your business after a few rounds of fundraising.
• Access to this kind of capital is limited and often requires connections.
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Comparing Early Investors, Angel Investors, and Venture Capitalists
Both angel investors and venture capitalists are early-stage investors. However, there are some key differences between them. Here’s a look at how they compare.
Similarities
Both venture capitalists and angel investors seek to get in on an investment opportunity in the early or seed stage, and both invest money in businesses in exchange for equity. In addition, both types of early investors tend to cater to innovative startup businesses, often those related to technology and science.
Differences
Angel investors are wealthy individuals who invest their own money into startup ventures, whereas venture capital investors often work for a risk capital company where they invest other people’s money.
Another key difference: Angel investors tend to be more willing to take a risk on and lend to a startup that may have nothing more than an interesting idea, while venture capitalists generally want to see growth potential before getting involved.
Venture capitalists also tend to invest larger amounts of money — and get higher equity stakes — than angel investors.
Finally, angel investors typically prefer to be passive investors, whereas venture capitalists usually demand that they have some level of operational control.
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The Takeaway
As an entrepreneur, you know access to capital is crucial for growth. One way to raise funds during the early stages of your startup is to bring in an investor, such as an angel investor or venture capital firm.
Early-stage investors can give you the capital you need to get your business to the next level, along with guidance. In exchange, you’ll need to give up equity as well as some control over your business.
If you’re unable to secure an early-stage investor or aren’t willing to give up equity in your startup, there are other early-stage funding options to explore, including small business loans, crowdfunding, and small business grants.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What are early-stage investors?
Early-stage investors provide capital to startups while they are still in the market research or development stages in exchange for equity in the company.
What does an early-stage investor typically look for?
Generally, early-stage investors want to see a solid business plan, plus a viable product or service concept that fills a gap in the market and has potential for significant growth.
What is considered the early stages of a company?
The early stages of a company are when it’s still in the startup phase. An early-stage business is still focused on product development and building a customer base and has not yet reached the growth stage.
Photo credit: iStock/Jacob Wackerhausen
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