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Investors Can Back The Best Start-Ups By Considering Prior Funding

glass jar filled with silver coins and a plant growing from the top
Investigating prior funding sources when selecting a start-up to back can help guide investors toward the most promising projects
  • The ability to identify a promising start-up to support is a vital tool for investor success
  • Supporting new ventures has never been more important for economic recovery and growth, so investors are feeling the pressure to back the right start-ups
  • Considering prior funding could help connect investors to those entrepreneurs and ideas most likely to flourish

Global events such as Covid 19, and the ongoing war in Ukraine have not only ravaged our societies, they’ve also left spiralling inflation in their wake. The World Economic Forum has recently reported that the UK is entering a new 40-year high in inflation, the US Federal Reserve (which represents the world’s strongest economy) is also now increasing interest rates after forecasting an imminent recession and even Switzerland, known for its robust banks, has made a surprise move to raise its policy interest rate for the first time in 15 years.

It all sounds like death by a thousand cuts for markets, and any hopes of prosperous economic growth. Governments may implement policies to alleviate some of the doom and gloom, such as the furlough scheme in the UK, which provided some relief to businesses during the height of the pandemic and, looking forward, schemes to provide discounts on soaring energy bills. However, such measures only paper over the cracks at best, and are not designed to be long term plans.

In these testing times, it’s vital for industries to be smart. To stretch what they can do with their money, their resources and their ideas. Take the energy sector for instance. Current global conflicts have made access to increasingly scarce fossil fuels even more challenging, leading to dramatic increases in the price of fuel and electricity, compounding an already complex challenge of how we power our world in a more sustainable way. The UK has commendably begun a transition to achieving net zero emissions by encouraging alternative ideas for cleaner, more readily available fuel sources to come to the fore. But a thriving economy is the minimum requirement for the country to develop beyond fossil fuel dependence. And here is where the problem becomes infinitely more complex. The economy, currently, is not thriving.

For innovators who possess those much needed fresh ideas, who see that see the gap in the market and aspire to build a company or product to fill it, they often also need investment. Solid proposals, a coherent business plan, an engaging pitch and realistic projections of performance are the minimum requirements to look attractive to investors. But competition is rife.

Governments which have previously been keen to put their money behind emerging enterprises, historically, haven’t seen the best success rates, and the pot for entrepreneurs to bid for will, as costs rise, become ever smaller, leaving non-governmental sources such as investors and venture capitalists to shoulder the burden of finding the next big thing.

For investors looking to get the best bang for their buck, whilst already established businesses can be analysed in a variety of ways to predict their future success or failure, for emerging ventures the decision isn’t as easy as simply picking the best or most appealing idea. Investors may be motivated by start-ups with tech prowess or a solid social cause, but they also need to feel confident of their success, in order to ensure sufficient returns on their investment and to protect their reputations so that they can continue to build a successful investment portfolio. It’s a tricky business to continuously back the right horse.

In taking such diligent approaches to their investment decisions, are there other factors that should be weighing more heavily into investors’ consideration? According to research from Nyenrode Business University in the Netherlands, there just might be another readily available source of information that can help steer investors toward the most promising projects – prior funding sources. Dr Job Andreoli, Assistant Professor of Finance at Nyenrode, found that while practice and academia point to only two investment considerations; the entrepreneur and the venture, a third consideration deserves attention too: prior funding sources.

As the private sector does not offer the same transparency and freedom of information as the public sector (nor does it have any obligation to do so) Dr Andreoli’s study analyses sources that are publicly available; crowdfunding or Initial Coin Offering (IOC). His research suggests that because this information on prior funding is available to investors, it can be a significant measure of assessing the value of future investments, noting that they would otherwise decide based on other factors such as education, experience, age of the entrepreneur and the venture’s industry. These are undoubtedly useful criteria for investors, but prior funding could be the golden ticket of being able to comprehensively analyse a venture.

In order to show how his research can aid investors, Dr Andreoli uses the analogy of the jockey and the horse. The jockey is the entrepreneur and their traits and the horse is the venture and its traits. The investor, as a relative outsider, is the spectator in this scenario, so they have an inability to have the same level of information as the entrepreneur about the venture. Spectators to horse racing will consider a horse and jockey’s training and previous performance before placing their bets. Similarly, prior funding can be used as a way to assess prior performance and future prospects. Being swayed by impressive odds, or a savvy pitch might just get you a big win occasionally, but these aren’t the key to finding consistent success.

The investment selection process, Dr Andreoli says, appears to be the most important determinant for investment success – even more so than any coaching or networking activities conducted after having selected the venture.

For low level investors looking at building up a profitable portfolio, Dr Andreoli says this insight could prove highly valuable. But the heavyweights would also do well to do a little more research to curb their ill judgement. Dr Andreoli research suggests companies such as Amazon, Facebook and Netflix, have a lot to learn as their actual success rates when it comes to backing winning ideas is actually quite low. Measured by number of other elements, merely 21% of VCs’ investments generate more than the capital that was invested.

The research also suggests this new consideration for investors is especially relevant because it comes at a critical point: early-stage ventures are riskier, resulting from their developing proposition, limited market proof and lack of collateral. Building trust and transparency is equally important from the start: over exaggerating by founders or incoming CEO’s can often, irreversibly, undermine shareholder belief and business success if previous research is anything to go by. 

By, James Dugdale

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