Why would an investor invest in a pre-revenue company?

Q: Why would an investor invest in a pre-revenue company?

This is an important question to understand.

If you don’t understand it, it’s hard to understand how early-stage venture capital works.

If you are a start-up investor, in a perfect world, you would wait. As long as you could. To get more data, more information, more traction. To see if the team can really do it. If they can close just a few more customers. Just grow a little bit faster. Just ship a few more features, etc. You’d … wait.

And you’d even wait if that meant the price went up a tiny bit. As long as the price doesn’t go up too much, it’s still generally better to wait. And de-risk the investment.

So you only don’t wait if you are sort of forced to act now:

  • You are worried the opportunity will pass you by. If someone else is going to do the deal, you may need to invest now. If you really want to do it. There are 1000+ seed VC firms.
  • You are worried it will get too expensive. Every fund and firm has a sweet spot. If the deal gets too expensive, it may pass you by just for that reason. Many funds have structural limitations on valuations.
  • You are worried you can’t get enough ownership unless you invest now. Professional investors have % ownership targets. Those are easier to achieve if fewer folks are in the deal. The earlier you invest, the easier it is to get your target ownership.

So if there’s no urgency, and no price issue, and no ownership issue … many investors will try to wait. They’ll take more time doing diligence. Do more reference checks. Dig in on the model more. Get to know the team better (this is important). And ideally, wait a few months if they can before issuing a term sheet. Another 2 months of learnings can materially de-risk an investment. It really can.

And if they really want the deal, and see this as their only window … they can get you at term sheet this week.

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Published on December 8, 2019

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