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Late Stage Venture Investing

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Published:

April 3rd, 2020

Categories:

Learning, Themes

Author:

Carmine Meoli


We often hear about post-IPO investing where retail investors try to follow in the footsteps of venture capitalists and angel investors and snatch up a piece of a startup’s potential valuation boost after it has undergone its Initial Public Offering (IPO). What is not discussed too frequently outside of venture capital and angel investor circles are the potential benefits of late stage venture investments, also known as pre-IPO investments, otherwise known as getting in on the action before the startup promise is released to the masses.

As the Coronavirus is shaking up traditional economies, it may make sense to shift the focus on new business models

In the current market environment, making a decent risk-adjusted return in traditional asset classes has become rather tricky. Startups are looking to commercialize business models of the future, with promises for new inventions, innovations, and technology that stands to change the business landscape forever. As the Coronavirus wreaks havoc on worldwide economies, now is the time to invest in those companies that have set out to look beyond the current market uncertainty. The biggest challenge for investors today: when to invest in such a startup, and how to get access to an investment opportunity at all.


Challenges for investors investing in startups

Problem #1: Investing very early in a startup can either be impossible, risky, or difficult to analyze or any combination of those factors. Early startups are at an idea stage, which means valuations are nearly impossible to specify. After all, the focus is on potential growth, and not yet on actual profitability. Which means there are few significant numbers to base investment decisions on. Problem #2: Investing at or post-IPO could resemble partaking in a Russian Roulette. The IPO valuations can be sky-high, often with a post-listing dip that has nothing to do with the firm, but rather, the overall exit market. Therefore, there must be a strategic investment window in which one can reap most of the benefits of startup investing but with the least amount of risks and challenges.


Pre-IPO Investing as the sweet spot for visibility and predictability

There’s that sweet spot, known as the pre-IPO investment, where one can gain visibility, and with that, increased predictability, yet being spared the public mayhem and oversubscriptions that come with it. In other words, investing in growth equity positions of late-stage startups, who have a clear path forward to going public, reduces the risk compared to early-stage investing.


Some of the biggest high-potential companies are still private

The challenge is identifying when this pre-IPO time is right, as well as getting access to the startups during this critical time. Some of the biggest companies in the world, like Robinhood and Airbnb, are still private. If one could gain access to their equity before an IPO, the payout potential could be enormous.


Digital business models are here to stay

Today, more than 4.5 billion people use the internet. It seems redundant to mention that digital business models like the ones from Revolut, TikTok, Zoom, Transferwise, Coursera, or digital platform businesses could now reach a breakthrough even faster due to the current global situation. One meme going viral right now is what supposedly will be accelerating the digitalization in companies:

While this meme, of course, should be consumed tongue-in-cheek, we believe there is more to it than many think. A lot of companies with intrinsically digital business models are still private. This fact holds enormous potential for those with access to pre-IPO investments.


The unique appeal of the digital platform business model

In the area of the digital platform business model, there is a concept called “harnessing spillovers” which helps to grow the volume of interactions rapidly. For example, an e-reader issues book recommendations from past purchases and thus creates value for other participants, who, in turn, consume more. We can assume that this dynamic is a sign of a strong network effect amongst interactions of the same type. As we are increasingly going digital, whether it be just for buying or even reading online, this effect becomes even more relevant. It is likely to boost sales and revenues. One can expect the same effect to benefit providers of digital education, another highly scalable business model that relies on strong network effects. There, we can see an increasing influence of data analytics to offer students features such as advanced tracking of their learning progress and overall activity levels. It goes hand-in-hand with the growing demand for personalized individual learning.


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