3 Categories of Startup Growth Potential

Investor Returns Depend on These Startup Growth Categories

Startup growth depends largely on how aggressively the startup pursues that growth. In turn, the more aggressively a startup pursues growth, the bigger the exit and the higher return on investment that investors seek.

If return on investment is your primary reason for angel investing, then you should assess a company’s long-term growth potential before buying its shares. Invest only in startup companies with high growth potential, among other positive characteristics, such as strong management teams and revenue forecasts.

Types of Startup Growth

Evaluating growth potential is highly subjective—more dependent on the founders’ vision and goals than on quantitative measures. We suggest that you conduct a thorough review of each issuer’s offering documents, operating history, marketing strategies, financial forecasts and team profiles. Then, sort the companies into three startup growth categories: lifestyle, middle-market and high-growth potential.

Lifestyle Companies

Lifestyle companies provide good incomes for their founders, but they do not pursue growth aggressively. The founders are not inclined to take big risks that may jeopardize their (and their families’) long-term security. They are reluctant to give up control to people outside the family, preferring to keep their companies closely held, rarely seeking financing beyond community bank loans and early-round crowdfunding.

Lifestyle companies are usually not destined to be acquisition targets (at least not until the founders retire) or IPO candidates, so they wouldn’t be considered prime angel investment opportunities—unless your motivation is related to community development or social factors rather than ROI.

Middle Market Companies

Middle-market companies pursue growth aggressively until their annual revenues are $50 million to $2 billion, and then level off or continue to seek modest growth. These companies should provide equity investors with income in the form of dividends and gradually increase in share value when they mature. They may also be prime opportunities for strategic investors. They may be acquisition candidates eventually, but not soon enough for equity investors looking for near-term divestment.

In addition, you can expect middle market companies to remain private (not file an IPO). Middle market companies are more likely to be held longer, and secondary buyouts have become the preferred exit strategy over an IPO exit. In fact, the first quarter of 2019 was the first time since 2009 that there were no IPO exits for the middle market.

High-Growth Companies

High-potential, entrepreneurial companies pursue growth aggressively and quickly. The founders want the company to be big—maybe very, very big—not only so they can earn a fortune, but also because it may be necessary in order to achieve economies of scale and maintain market share in a hypercompetitive environment.

The founders of high-potential, entrepreneurial companies typically thrive on risk taking, innovation and the excitement of growth. Exit strategies are paramount. They aim to be acquisition targets or IPO candidates, representing jackpot-grade exit events for early investors.

Education, Experience, Judgment

To judge potential startup growth, you need education and/or experience in the field where the startup operates. Reliable studies have shown that returns on investments made by angel investors are positively correlated with the number of years of experience in the industry in which the investment was made.

Today, in hindsight, it is easy to categorize the 1976 version of Apple Computer as a high-potential entrepreneurial company. It is quite another thing to have been Mike Markkula in 1976, visiting the scruffy founders Steve Jobs and Steve Wozniak in the garage where they had just built the Apple II prototype, and recognizing this as a high-potential startup worth investing in. Wozniak recently pointed out that if you had asked average consumers in 1976 if they would like to have a personal computer, they would have responded, “What’s a personal computer?”

It helped that Markkula had a master’s degree in electrical engineering and worked as a marketing manager for Fairchild Semiconductor and Intel, where he earned millions on stock options before he met Steve and Steve. In other words, Markkula had the education and experience, not to mention keen judgment of character, which enabled him to recognize Apple’s potential. He invested $80,000 in the company in return for one-third of the equity (he also loaned Apple $170,000). That transaction valued the company at far less than $1 million. When Apple went public three years later, the company’s value soared to $1.778 billion, and Markkula’s share was worth something like $200 million.

Leverage the Wisdom

One advantage of investing via equity crowdfunding platforms is that you can collaborate with other investors—leveraging the wisdom of the crowd—to assess growth potential. If you lack experience in a particular field, you may be able to rely on crowd members who have it. Be sure that the platform shows investor profiles, so you can verify their experience.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Advanced Investing Topics: Unicorns and Pre-Unicorn Scalable Private Company Propositions and Due Diligence Before Investing. This is an updated version of an article that first appeared in August of 2015.]

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