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| By Chris Graebe |
Startup investing can be as frustrating as it is lucrative. Take this scenario …
Let’s say you conduct due diligence researching a potential investment opportunity and decide the startup is worthy of your support. However, as soon as the amount hits their bank account, the founders whiplash you like an old rickety roller coaster.
They move on and leave you in the dark in record speed. No updates, no emails, no news, no thank you. No idea if the startup is even still in business.
Getting the cold shoulder can be one of the most frustrating parts of early stage startup investing. Take heart, though. I’m going to take as much frustration out of the experience as possible.
Here are three hidden truths to help you better understand what has likely happened to your money … and when to expect payday.
Now, let’s dive in.
Hidden Truth No. 1: They’ve Already Spent Your Money
I don’t know how to sugarcoat this. So I’m just going to say it … they’ve already spent your money.
Now, I'm kind of joking … but not really. You see, the reason startups raise money is because, well, they need it. Maybe they use it to hire staff, to market a product or to build inventory. It could even be to take a monthlong executive retreat to Bali.
Let’s hope your money didn’t fund the retreat. Regardless of how, cash flow is king for growing and scaling a business.
Unfortunately, sometimes companies do actually blow all your money. And it’s not a pretty thing.
I remember the end of 2022 when news broke that one of the most successful startups to ever raise funds in the equity crowdfunding space quickly and unexpectedly shut its doors.
I’m talking about NowRx. Hopefully, none of you were caught in the crossfire. Here’s how the situation unfolded …
The company seemed to be solving a problem and had a significant opportunity to scale. Americans' challenges with gaining access to affordable prescription drugs are well documented. NowRx set out to solve that.
According to Yahoo! Finance, NowRx was able to raise $27 million from retail investors, considered one of the most successful raises ever by the crowdfunding industry. Even Business Insider gave NowRx the role of "disruptor."
However, it would need to compete against the deep pockets of GoodRx and Mark Cuban's venture Cost Plus Drugs.
In the end, NowRx had a $1.5 million monthly burn rate and lacked the extensive capital to scale. Despite having an experienced marketing team, it was not a sound foundation from which to build.
NowRx attracted a total of $79 million … $25 million of which came from retail investors who will never see a penny of it.
The good news is that this isn’t a tale for all startups. And the investment-worthy ones will put your money to good use and scale over an appropriate time frame.
Hidden Truth No. 2: Converting to Equity
You need to make sure your investment is converting to equity so that one day you see your money again.
Let me explain. Most early stage startups typically don't let you invest and receive actual equity in the company right out of the gate. You'll see offers for a convertible note or safe note — simple agreements for future equity that gives the founders time to grow the company and figure out details along the way.
One way to understand this approach is by looking at the life of an American hero. That’s right, I’m talking about Daniel LaRusso, aka, the Karate Kid. Think of him as a budding startup that you just invested in.
He’s the new kid on the block and trying to make an impact on a brand-new town. Well, he heads into the world but is met by one difficult challenge after another. The Karate Kid doesn’t know what to do or who to turn to until he finally finds an adviser and investor in Mr. Miyagi, aka you.
So, you invest in the Karate Kid. But this time you send him back out into the fight with some confidence … and capital in hand. Ultimately, we want to see our grasshopper win the best-in-class trophy (grow and scale properly, improve efficiency and attract more funding).
This is right around the time your investment converts to equity, and you own a piece of the company. You’re locked in now. And once things smooth out and a steady stream of revenue is flowing in, the Karate Kid turns pro by exiting via an IPO … and he begins returning your money — and then some.
Hidden Truth No. 3: Your New Best Friend, the Transfer Agent
Many investors in early stage startups don’t realize they’ll eventually deal with transfer agents — or at least that’s the goal!
They’re the ones who will give you your money when the big exiting day comes. Whether it’s via a big, fat check or shares prior to an IPO, the transfer agent hired by the startup actually takes care of the transaction.
It’s standard operating procedure today for a transfer agent to serve as the middleperson between the company and investors. He or she will communicate any updates, corrections on personal information, exact number of shares or amount of money due, receipts, etc.
So, there you have it: Three truths that no one really talks about regarding the startup investing process.
Now, I’m sure you’re itching to know where your Karate Kid is in his journey. So, I’m going to share a simple statement that you can literally copy, paste and drop on the same web page that you made your initial investment on — however long ago that might’ve been.
It goes like this:
“Hey there. I invested in your company back in (fill in the month and year.) I was wondering if you could provide your investors with an update. How’s revenue? How’s my investment? Has it converted into equity yet? Tell me some of the company’s biggest milestones.”
Paste the above paragraph on the initial campaign page, sign it and wait for an update from the founder. I bet you’ll get one right away.
Hopefully these nuggets of truth will make a wild investing roller-coaster ride a little more enjoyable and lucrative.
Until next time, my friend!
Happy hunting,
Chris Graebe
