Aggressive Investor? Read This.
Building a portfolio of next-generation technology companies.
“Venture capital is all about capturing the value between the startup phase and the public company phase.”
— Fred Wilson, Partner at Union Square Ventures
In this post, you’ll learn:
The startup lifecycle
Why pre-IPO investing is so lucrative
How to begin investing in pre-IPO companies
The Startup Lifecycle
I want to preface this section with the disclaimer that things are 100X more complex than I make them out to be. Building a billion-dollar company from the ground up is insanely difficult and takes several (7-13) years.
— Problem / Solution
Every company we’ve ever purchased from, heard of, or worked for started from wanting to do the same thing — solve a problem.
That problem could have been a lack of innovative smart devices (Apple), an abundance of unused bedrooms around the country (Airbnb), or a growing desire to purchase cryptocurrencies (Coinbase). No matter the company, the first goal has always been and will continue to be “solve a problem.”
Let’s pretend you have a dog, like myself. Every year during the 4th of July, as well as during your casual thunderstorm, your dog freaks out. Completely loses their mind and runs around the house howling and barking.
After doing some research, you’ve discovered this is not only a problem you’re facing, but a problem millions of dog owners around the world face as well. You’re determined to find a solution and start a company — selling this solution to all dog owners around the world.
— Testing the Minimum Viable Product (MVP)
Before any company can “go to market” and sell their solution to the world, they need to have a solution. This phase of the startup lifecycle is identifying, testing, reiterating, and finalizing that solution.
Before you can truly “solve a problem,” you need to make sure your solution to the problem effectively solves the problem at scale.
You’ve now begun to test different ideas to calm down your dog — from feeding them different foods before thunderstorms to wearing tight harnesses. You’ve built prototypes, gathered feedback from other dog owners, and even tested your solutions out on different breeds of dogs.
After several months of research, you’ve finally found a solution that effectively solves this problem at scale. You created a liquid that when slurped up by dogs before a thunderstorm starts — can completely calm them down as if it wasn’t even storming.
— Product-Market Fit
Once a company has built their unique solution to a problem, it’s time to begin building a business around it. A business that has repeat customers is one of the best gauges of product-market fit — people are buying the solution not just once, but again and again because of the continued value it brings.
It’s one thing to solve a problem, it’s another to build a business around this solution.
You’ve set up an online store and you’ve begun to sell this dog-calming liquid to dog owners. Your product has come up in conversation organically on subreddits and people are making TikTok videos showing their friends just how cool your product is.
Customers are leaving reviews online and some are even buying more. You also offer a monthly subscription service and people are loving it.
This is the hardest part of the lifecycle for startups — scaling. The reason this part is so hard is not because the product / solution doesn’t work, or that the customers aren’t happy — it all comes down to the execution of the CEO.
Everyone has ideas. Everyone has a solution to a problem. Everyone has an online website and a few thousand followers on social media. But only very specific CEOs are able to leverage their education, work ethic, leadership skills, and agility to scale a business from “online website” to “worldwide enterprise.”
Brian Chesky, the CEO of Airbnb, successfully built a small business that identified vacant bedrooms located in San Francisco, CA. How can they now build a business that identified vacant bedrooms located in every city in America? Around the world?
Your liquid solution is selling like crazy, and demand is picking up. You’re beginning to realize this is no longer a one-person small business — you need to hire and train employees, invest thousands of dollars in renting a warehouse and buying equipment, and begin traveling to different manufacturing facilities to negotiate lower prices as your fixed costs begin to increase.
You realize to continue scaling your business you need more money — you raise money from venture capitalists who align with your mission and want to help you build your business for the long-term.
This phase is where several companies we know and love are currently operating. Hockey stick-like growth in revenue has slowed to high single / low double digits, profit margins have become optimized, and market saturation is happening.
Think about it like this — Netflix. The company has been around for several years and in the beginning it was all the rave. Everyone was renting DVDs, streaming content from their website, and even buying a larger subscription for their family-wide streaming needs.
Where’s Netflix now? Mature. Crazy subscriber (and revenue) growth has slowed tremendously, profit margins have improved over 10+ years ago (despite recent operation troubles), and market saturation has certainly occurred.
This is where most companies end up either becoming free cash flow machines (profit margins are optimized) and pay their shareholders a healthy dividend, or they die.
You did it! Over the last 9 years you grew your business from a “solution to a problem you were experiencing” to a “worldwide enterprise.” Your product is now being sold in every big box retailers around the world or online at-scale. You’re expanding by inventing new products on an annual basis.
You even had an IPO 4 years ago! You’re now a publicly traded company on the stock market, allowing anyone with a brokerage account to own a little bit of equity in your growing business.
Why Pre-IPO Investing is so Lucrative
Let’s rewind back to our example above — remember during the scaling phase when you realized if you were going to turn this “small business” into a “worldwide enterprise” you needed some additional capital?
You were a one-person shop at the time. Demand was there, you just didn’t have the tools and resources to meet that demand — hiring and training employees, investing in buying new equipment and renting a warehouse, etc.
— Insert Venture Capitalists
Venture capitalists (VCs) are either individual people (angel investors) or a group of people (firms) that want to help budding startups grow into worldwide enterprises. They help by giving them money to grow their business, offer advice from past experience of growing their own business, and introduce them to people they should hire.
Venture capitalists provide value to entrepreneurs in a ton of different ways. Every situation is different as every individual investor has unique skills and experience they bring to the equation.
In exchange for their capital investment, VCs are given stock in the company. Depending on how far along the company is in their lifecycle and how much money is invested, this stock usually represents between 1% to 20% of the company.
A wonderful example of this is Peter Thiel investing $500K in Facebook back in 2004 — he invested into the company at a $5 million valuation, giving him a 10% equity stake. Facebook went to IPO in 2012 at a $105 billion valuation, 21,000X more valuable than when Peter Thiel bought in.
If Peter Thiel sold his stake in Facebook at $105 billion, his $500K would have been worth $10.5 billion —an insane return on investment. He sold some 16 million shares at IPO, yielding ~$640 million. However, if he held his shares and sold when the company entered the $1 trillion club, his $500K investment would have been worth ~$100 billion (assuming minimal shareholder dilution).
Now you see just how lucrative venture investing can be! As the quote at the top of page says, “Venture capital is all about capturing the value between the startup phase and the public company phase.” Facebook didn’t IPO until it was already worth $105 billion — only representing a ~10X once it hit the $1 trillion price tag.
However, the venture capitalists that were able to invest in Facebook at $5M, $50M, or even $1B saw insane returns on their money because they were able to capture that value pre-IPO.
— How do venture capitalists lose money?
Very easily — by investing into a company that fails.
This could mean the company is unable to execute on a path to profitability and completely runs out of money (insolvency). This could mean an outside force inhibits the company’s ability to make money i.e. regulation by the government. This could mean competition heats up and your customers leave for someone else with a cheaper product.
Failing comes in a lot of shapes and sizes and is much more common than success.
— How do venture capitalists make money?
The company they invested in gets acquired (bought) by someone else — usually a larger competitor, or they IPO.
Like I said above, there are several more ways to lose money as a venture capitalist than there are to make money as one. This is why 97% of a venture capital firm’s profits come from the returns generated by a single company.
Pre-IPO investing in budding startups is so lucrative (and dangerous) because you’re betting on the long-term success of a company before anyone else. You’re investing in a person / business before anyone else — before the company has a product, has customers, or even a website.
As a venture capitalist, you’re taking on all of the risk — think Shark Tank.
But if you’re correct, you stand to make a lot of money as the value of the business you own equity in continues to rise over the coming several (7+) years.
How to Begin Investing in Pre-IPO Companies
Generally speaking, it’s really hard to get access to these type of deals. I don’t know about you, but when Shopify, LinkedIn, or Bumble were raising money — they didn’t send me an email saying “Hey Austin, we’re looking for investors and would love to include you in our next round of funding.”
Instead, they reached out to VC firms with long track records of success like Bessemer Venture Partners, Ensemble, or even Union Square Ventures and asked them for their financial and intellectual support.
If you’re an entrepreneur looking for VC funding and see these are the type of companies that have taken investment from a VC firm like Bessemer or Ensemble, you get very excited! They all have had successful exits (acquisition or IPO).
Haha — and I don’t blame them! I’ve never taken a company public (IPO). Heck, I rarely go out in public! Of course I’m not going to see the CEO of Shopify asking for my financial support.
Then how exactly are we going to invest in budding startups, Austin?
— Introducing the Fundrise Innovation Fund
As you all know, I’ve been a user (and investor) of Fundrise for years now. I discovered them while reading Morning Brew back in 2019 and loved the idea of diversifying my portfolio into commercial and residential real estate.
I’ve had the pleasure of meeting Ben Miller, the CEO of Fundrise, and am incredibly excited about how this company is not only unlocking access to institutional-grade real estate for the masses — but now also high-profile venture deals.
“Investing in high-growth private technology companies has proven to be one of the best performing investments strategies of the last 50 years. However, these investments have remained almost entirely inaccessible to individual investors.
We’re changing that, aiming to give all investors the opportunity to invest in a portfolio of top-tier private technology companies before they IPO.”
Here’s the deal — in 2012 Fundrise paved the way for retail investors like ourselves to begin fractionally investing in institutional-grade real estate. Now, 10 years later they’re paving the way to allow retail investors to invest in mid to late-stage technology companies — pre-IPO.
— The Problem They’re Solving: Staying Private Longer
Remember when we talked about the scaling and maturity part of the startup lifecycle? Traditionally speaking, at some point during the “scaling” part, companies make their debuts on the public markets — allowing the founders the opportunity to cash in on all of their hard work, as well as raise much needed capital to continue growing their business.
However, over the last several years (Snowflake is a wonderful example of this) the most lucrative privately-held companies (specifically technology) are staying private for longer. This isn’t inherently a bad thing, but it completely keeps retail investors out of the equation — making us wait until the company is already worth $100s of billions before being allowed to invest.
Snowflake (SNOW) was a very hot IPO in 2021 — raising $3.4 billion at a $33 billion valuation. Why didn’t they IPO at $5 billion? $10 billion? Remember our Facebook example? $105 billion, offering “only” a ~10X.
“This problem has been exacerbated by the reality that increasingly, more and more high-growth technology companies are choosing to stay private even longer.
During the 90's and early 00's, companies like Amazon and Google went public relatively soon after being formed, while companies today are waiting on average 10 years longer.
The result: individual investors confined to the public markets are missing out on a substantial portion of the returns generated by the next generation of industry leaders.”
— Investment Strategy
By the looks of it, Fundrise is going to use the $1 billion in cash they’re raising for this venture fund to participate in funding rounds of late-stage technology companies. The first few that come to mind right now are Stripe, Airtable, and even Chime.
“The Fundrise Innovation Fund seeks to achieve its investment objective by investing in a diversified portfolio of high-growth private technology companies.
While the Fund expects to focus primarily on late-stage companies, it is intended to be a “multi-stage” Fund investing in both early-stages and late-stages, as well as holding some public equities.”
If you’ve been an investor on Fundrise for a while, you more than likely have been invited to participate in this fund. If you haven’t yet opened an account with the platform, consider doing so by clicking this link.
To learn more about Fundrise and my investing journey on their platform, I’ve linked out several posts I’ve shared over the months walking you through everything.
Disclaimer: This is not financial advice or recommendation for any investment. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.