The post What is a Previous Exit Founder, and Why is it Important in Startup Investing & Equity Crowdfunding? by Caleb Naysmith appeared first on Benzinga. Visit Benzinga to get more great content like this.
Equity crowdfunding and startup investing are among the most dynamic and potentially lucrative investment sectors.
Venture capitalists and everyday investors who pick the right startup can build tremendous amounts of wealth in a relatively short time span. That’s a big part of why so many people are looking to get a piece of this action.
As is the case with any hot investment sector, everyone is looking for an edge. This is as true for investors as it is for the startup itself. One of the biggest advantages a startup can have is a previous exit founder. Keep reading to find out what a previous exit founder is and why having one is so important to startup investing.
What is Equity Crowdfunding/Startup Investing?
Equity crowdfunding, also known as startup investing, is a process where investors pledge capital to a new venture in exchange for a current or future piece of the equity in the company. It’s a popular way for entrepreneurs to raise money because lenders generally see new ventures with no history of success — or assets to secure a loan — as high credit risks.
The return from loan interest is smaller than the potential gains with an equity crowdfunding investment but also much more reliable. Historically, this has left entrepreneurs in a bind. They need funding, but they can’t get it from a bank — or at least not on loan terms that are good for a new business. That’s why venture capital (VC) funding has long been the first option for entrepreneurs to secure the funding they need to get new ventures off the ground.
But the Jumpstart Our Business Startups (JOBS) Act of 2016 changed the game for both entrepreneurs and investors. Specifically, the JOBS Act allowed entrepreneurs to raise capital through crowdfunded investment offerings. This opened the world of startup investing to a whole new class of investors: everyone. It also gave entrepreneurs a much wider pool of potential funding than VC, which has long been a closed loop that was only available to the most well-connected entrepreneurs.
Important Aspects of Startup Investing
Revenue: Many different variables must align for a startup — and by extension a startup investment — to be successful. One of the most important factors is revenue. Any successful startup must be able to demonstrate that it can generate revenue.
Although startups typically have a high burn rate and require lots of capital, a startup’s ability to generate revenue serves as an indicator to investors that the startup is viable. Theoretically, once the burn stops, that revenue should turn into profits for both the startup and its investors.
Revenue also translates into momentum. As the startup begins generating more revenue, it begins to generate momentum. This momentum is important because it helps to bring the company into the public arena. That helps to bring new clients, which translates to more revenue. It also creates a positive view of the startup’s potential profitability in the eyes of potential investors.
Size of the industry: Another important consideration is the size of the industry the startup will operate in. The automotive industry, for example, is worth billions of dollars per year. So when a company like Tesla Inc. (NASDAQ: TSLA) enters the market to make high-quality all-electric cars, investors realize that even a small slice of that pie could be very profitable.
By contrast, if the startup is entering a niche industry with limited appeal beyond a hard-core group of consumers, the profit potential to attract investors won’t exist. Any startup that’s going to be successful needs to be in an industry with a market big enough to make it profitable.
Examples of industries of sufficient size to make a startup investment appealing include:
- Automotive
- Biotech
- Mobile technology
- Computing
- Social media
- Healthcare
A startup doesn’t necessarily have to be in one of these industries to be successful. But it does need to be in an industry that is large enough to allow the startup to build a sizable customer base and generate profits for equity investors.
The founding team: No matter how savvy or astute a startup’s founder is, they need a quality team around them. The founding team, along with the founder, functions as the startup’s brain trust. They are the people most responsible for helping the founder’s vision come to life.
A solid founding team should include people who have a proven track record in the industry the startup functions in.
The founding team should also be able to execute specific functions that are critical to the startup’s success. No matter what industry the startup is in, without a founding team that can execute the business plan and lead the various departments that make up the company, its chances of long-term success are low. All of this is why potential investors are attuned to the depth, quality and cohesion of the startup’s founding team.
What is an ‘Exit’ in Startup Investing?
An “exit” is an important milestone in the life of a startup. Exits occur
when the startup has reached a point of liquidity, meaning the original investors have the ability to sell their shares.
In a successful exit, the founder has built the company to a point where it has a “liquidity event.” Successful exits also happen when the founder strikes a deal to sell the startup to another company. In either case, the founder and the investors have made a significant profit in a successful exit scenario.
Other examples of a successful exit would include:
- Initial public offering
- Secondary market offering
- Merger with another company
Why Are Startup Founders so Important?
At the end of the day, a startup is really nothing more than an idea. No matter how good the idea is, if it can’t be executed, it’s worthless. Startup founders are so important because they are the ones who help make the idea reality. They are chiefly responsible for taking their idea from the drawing board into the real world and proving it can work.
A large company has hundreds or even thousands of people who can execute business plans. In a startup, there is the founder and the founding team. The ultimate success or failure of the business is heavily dependent on their ability to plan and execute their vision for the startup. Think of a sports team. Regardless of how individually talented the players are, the team isn’t going anywhere without a great coach and a talented coaching staff.
In the case of a startup, which has no history of success, its viability is dependent on the quality of the founder. The founder is chiefly responsible for the following mission-critical tasks:
- Raising capital
- Recruiting a founding team
- Making the everyday management decisions for the startup
- Executing the startup’s original business plan or altering it as necessary, according to market conditions
Without a solid founder, it’s unlikely the startup is going to get off the ground or reach a point where the founder will make a successful exit. That means the startup is also unlikely to make money for investors.
What is a Previous Exit Founder and Why Are They So Important?
A previous exit founder is an entrepreneur who has successfully led a startup all the way from the idea stage up to a successful exit. They are important to any startup because their track record of success matters. Specifically, it matters to investors, most of whom will be much more likely to pledge capital to a startup led by someone who has a history of successfully running startups.
A previous exit founder has a solid network of potential investors they have made money for. The credibility that comes with having made money for investors in the past goes a long way. A previous exit founder’s network doesn’t just stop with investors. By virtue of their earlier success, they also have access to a founding team who has proven their worth.
When it comes to asking investors to pledge money to a startup, the network of previous investors and the credibility a previous exit founder brings to the table is invaluable. It’s not necessarily a guarantee of success, but it’s a solid indicator that the startup has a solid foundation. Historically, investors who invest in startups run by previous exit founders make more money. Along with this increased credibility, having a previous exit founder gives the startup a significant advantage when it comes to raising capital.
Previous exit founders are also much more likely to make a successful repeat exit with future ventures. Perhaps that’s why some previous exit founders report that “raising capital is laughably easy.” According to a Stanford University study, “Having a prior exit founder not only has a strong positive effect on current firm revenue,” but also that “the current firm has a higher chance of going public if the entrepreneur’s previous venture was acquired.”
Some VC firms almost blindly back previous exit founders in new ventures. The prestigious Sloan School of Management at Massachusetts Institute of Technology released a paper showing statistical evidence that previous exit founders have a higher chance of going public in their new startups than nonprevious exit founders. For all these reasons, previous exit founders are an important key to a startup’s potential success.
The post What is a Previous Exit Founder, and Why is it Important in Startup Investing & Equity Crowdfunding? by Caleb Naysmith appeared first on Benzinga. Visit Benzinga to get more great content like this.