How does my investment increase in value?
Over time, a successful company creates value by increasing the number of users, paying customers, and revenue opportunities. At inception, a startup has no value – a $0 valuation. A startup has a theoretical valuation as it begins to generate traction and the potential for sustained paying customers, which can lead to early projections about the potential value of the business. This is typically the stage at which individual angel investors contribute capital. It is not until a priced/equity round that a startup receives a definitive third-party valuation, such as $10 million. At that time, the startup is typically beginning institutional fundraising (such as a Series A round) and no longer accepts investments from individuals.
The investors who invest when the startup’s valuation is as close as possible to $0 may experience the highest returns as the valuation increases over time. However, this is also the riskiest time to invest, and the returns on startup investments are only realized in the future when a qualifying event happens that permits investor payouts.
The types of events that could potentially trigger a payout are:
- If the startup closes a qualifying round of financing that permits early investor payouts
- If new investors offer to buy out early investors at an agreed upon buyout price
- The startup gets acquired
- The startup does an initial public offering (IPO)
- Others, depending on the terms of the investment
These scenarios vary immensely depending on the terms of the offering documents, which are different for each company. It is important to understand the specific payout qualifications for each startup investment.