What Is Early-Stage Investing and How Does It Work?
In the world of entrepreneurship and venture capital, early-stage investing plays a key role in fostering innovation, supporting startups, and driving economic growth. But to anyone just beginning their investor journey, it can be overwhelming to figure out—from deal sourcing to due diligence and everything in between.
Intimidated by early-stage investing? Here’s a good place to start exploring what it’s all about, how it works, and why it’s essential for both investors and entrepreneurs.
A Snapshot of the Capital Landscape Today
Before we zoom in on early-stage investing, let’s step back and see how it fits into the bigger picture—particularly through a gender and equity-focused lens.
Currently, 11% of venture capital partners in Canada are women, and only 1.8% of venture capital funding in North America goes to women. Women are massively under-represented on both the investor side and the entrepreneur side, seeing as investors typically “bet on somebody that looks like them.” Stuck in this cycle, investors—who are majority male—are much more likely to bet on startups led by men.
What are we losing with a lack of diversity in the capital landscape? There’s overwhelming evidence that tells us:
Venture firms with at least one female partner generate 9.7% more profitable exits
Teams diverse in gender and ethnicity generate 30% higher multiples on invested capital compared to homogenous teams
Companies with at least one female or one ethnically diverse founder generate over 60%+ in business value
This huge gender gap is leaving massive amounts of money on the table: if women and men around the world participated equally as entrepreneurs, it could boost the global economy by $2.5 trillion to $5 trillion.
By 2030, women will control 65% of the nation’s wealth in Canada, so it’s due time that more women are writing cheques and diverse founders are being funded at their early stages.
Understanding Early-Stage Investing
Early-stage investing provides funding and resources to young companies typically in their seed or early stages of growth: they have a promising business idea, prototype, or initial product, but they may not have generated significant revenue or achieved profitability yet.
Unlike later-stage investments, which involve more established companies seeking growth or expansion capital, early-stage investing focuses on funding startups to help them bring new products and services to market, create jobs, and drive innovation.
New ideas bring the potential for high returns, but it’s important to note that it’s also high risk because these new companies don’t yet have a foothold in the marketplace.
Roughly 20% of startups fail in their first year, and around 60% will fail within their first three years.
So, why run the risk? Getting in on the ground floor can lead to huge payoffs when the company achieves significant growth or if they get acquired by a larger company.
For example, consider the success of Bumble: the game-changing, female-focused dating app.
Whitney Wolfe Herd, who had previously been a co-founder of Tinder, started Bumble in 2014 up against the Match Group (companies like Tinder, Hinge, Match.com, and more) and in one of the most crowded and established digital fields—over 90% of online dating startups fail. The big difference? Whitney carved out lucrative space prioritizing women's agency and addressing some of the challenges and drawbacks of those traditional dating platforms.
In 2021, Bumble announced selling its stock at $43 per share, raising $2.2 billion from investors—initially valuing the company between $6 billion to $8 billion. Bumble exceeded expectations in its opening trade and closed trading with a market cap of about $7.7 billion.
Key Players of the Early-Stage Investment Ecosystem
Investors in the ecosystem include angels, venture capitalists, private equity, and corporate firms prepared to take on the significant risk in hopes of securing substantial returns.
Angel Investors: Angels are individuals who invest their own capital in early-stage companies. Often having industry expertise and experience, angels provide more hands-on guidance and mentorship to the startup’s management team. Angels tend to have more flexible investment criteria and may be willing to invest in companies with less market potential or a less established management team.
Venture Capitalists (VCs): Venture capitalists are part of professional organizations raising capital from various sources (think: high-net-worth individuals, institutional investors, and corporations), which they then invest into early-stage companies in exchange for equity ownership. VCs are more stringent—expecting a proven business model, a strong management team, and significant market potential. While they may provide support, VCs are typically less involved in a company’s day-to-day operations.
How Early-Stage Investing Works
Here's a quick overview of the stages and key terms of early-stage investing broken down into four main parts: framework, evaluation, negotiation, and exit.
Framework
Investment Thesis: Before jumping in, ask: what factors affect your investment decision-making process daily? An investment thesis is a set of “rules” or an explanation of the underlying reasons for making a particular investment. Backed by research and analysis, the thesis aligns with an investor’s values and guides whether an investment is worth its costs.
Deal Sourcing: There are several methods to identify promising companies to invest in, including attending ecosystem events, networking, leveraging personal connections, crowdfunding platforms, or working closely with incubators and accelerators.
Evaluation
Due Diligence: After sourcing potential deals, thorough due diligence is necessary. Gathering relevant information, including the startup's business model, market potential, competitive landscape, team capabilities, and financial projections, helps determine whether a startup is a viable investment opportunity that can generate a sufficiently high return on investment (ROI).
Investment Decision: Based on the due diligence findings, it’s time to decide whether to invest in a particular startup. This decision is influenced by factors such as the startup's potential for growth, market demand for its product or service, competitive advantage, and alignment with the investor's expertise and investment thesis.
Negotiation
Negotiation and Terms: If the founder and the investor agree to move forward together, negotiations regarding the investment terms and conditions take place. The term sheet lays out the determined amount of capital invested, the ownership stake the investor will receive, and any additional rights or preferences associated with the investment.
Post-Investment Involvement: As mentioned in the breakdown of key players, early-stage investors often provide more than just financial support. They may offer guidance, mentorship, and access to their network of contacts to help the startup navigate challenges and accelerate growth. Some investors may also take on board seats or observer roles to actively participate in the company's strategic decision-making.
Exit
Liquidity Event: Who gets paid when? When there's a liquidity event (i.e. an exit), liquidation preferences dictate the order and amount investors get paid. With this, the liquidity waterfall is the priority and order in which cash flow is distributed to the existing stakeholders.
The Exit: As the startup progresses, it may require additional funding rounds to fuel expansion. Early-stage investors may participate in subsequent financing rounds or seek to exit their investment through avenues like acquisition, initial public offering (IPO), mergers, or buyouts.
How Do I Get Started with Early-Stage Investing?
Is the risk worth the reward in early-stage investing? It’s a big yes from us!
But note: although there is potential to see a return on your investment many times over, it’s not a get-rich-quick scheme. Because it takes time for startups to develop and grow, it's important to approach early-stage investing as just one piece of your portfolio. Diversifying across different asset classes and investment vehicles (think: GICs, RRSPs, RESPs, TFSAs, or stock and bond investments) is key for a well-rounded, long-term investment strategy. And remember, your portfolio should be regularly reviewed and rebalanced to align with your changing financial circumstances and goals.
Back to the rewards of early-stage investing—this strategy is worth the risk because:
It opens up more avenues and opportunities to invest
There are countless opportunities to build real wealth
You can align your investments with companies you believe in
You open yourself up to new and interesting opportunities
You’ll stay current and up-to-date on tech, innovation & the economy
Ready to get started? We love to hear it. Investing in early-stage startups supports you in building the future you want to live in—moving the needle on economic growth and job creation and driving a culture of innovation and entrepreneurship in Canada.
You’re already on the right path to getting started by educating yourself about the process (see: reading articles like this one!). Next, joining communities and learning from experienced professionals is invaluable for getting trusted information.
That said—registration for the Fall Cohort of Movement51’s Financial Feminism Investing Lab is open!
You’ll learn everything you need to begin investing with confidence. All of the above and more, we’re here to demystify your entire investment journey.
Run in collaboration with the Haskayne School of Business, University of Calgary, FFIL introduces participants to the ins and outs of early-stage investing and teaches aspiring investors how their dollars can power the next generation of future-fit, feminist businesses.
*Please note that the information provided in this blog is for informational purposes only and should not be construed as investment or financial advice.
