Investments in early-stage companies carry opportunities as well as risks, meaning that the value of the shares may increase or decrease. If the company fails, which is not uncommon, the entire invested capital may be lost.
Some (but not all) of the risks and issues of investing in early stage companies are listed below.
- The company may not perform as expected. The future performance of early-stage companies is more difficult to project than for more mature companies with a track record, established operations and customer relations. If the company performs worse than expected the value of the Shares may decrease and the Investor may lose its invested capital. Past performance is not necessarily indicative of future performance.
- The Investor may not find a buyer at the time it wishes to sell Shares. The shares of early-stage companies are rarely listed on an exchange, and if they are, they are not traded as frequently as the shares of more mature companies. The most likely opportunity to sell Shares will be if the Shares become listed on an exchange or if a financial or industrial company puts a bid on all or a large fraction the shares of the company.
- Early-stage companies rarely distribute dividends. Even if the company is successful dividends should not be expected in the near future. Most early-stage companies need the proceeds from their operations to grow the business.
- Dilution at future financing rounds. Early-stage companies will most likely issue more Shares to raise additional funding in the future. The capital may be used to finance the operations or grow the business. At a future financing round, the Investor will still own the same amount of Shares but a lower fraction of the total number of shares of the company. That is, a lower fraction of the company’s value will be attributed to the Investor’s shares.
- Risk for fraud. As unlisted companies are not as strictly regulated and covered by media as listed companies, the risk for fraud may be higher.