Startups come with a ton of challenges. It is difficult to make it in the startup world. Entrepreneurs struggle a lot to achieve the success they dream of. However, it can go terribly wrong for some businesses. In fact, a lot of startups don’t do well. We are certain that you have already heard the cautionary tales of startup businesses that have failed. So naturally, you may assume that there’s no hope for such businesses. No investor would be interested in a company that is failing or bound to fail. Well, that’s not entirely true. Investors keep funding these companies despite the high rate of failure. So, why do investors invest in unprofitable startups? What’s in it for them? People assume that the profitability of businesses. Well, investors have their reasons to do so. And surprisingly, they make sense. Let’s talk all about it in this post.
Why do investors invest in unprofitable startups?
So, why do investors invest in unprofitable businesses? What’s in it for them?
According to a recent research study, a lot of investors are willing to invest in startup businesses with little to no profits. The reason? Well, they do so because they hope that they will be successful in the long run. The study surveyed 2,000 venture capitalists and revealed anonymously their interesting investment strategies.
The research found that a lot of venture capitalists (46% to be exact) have funded startups with no profits before taking a chance on an innovative idea or business. Among the 1,500 people who were interviewed, most claimed that they had invested in at least one startup business with zero profitability. 59% of venture capitalists revealed that they did so because they believed these ventures could become profitable in the long run.
So, what can we understand from this? The main point is that the initial profit-making ability is not the key. Investors start funding even before a startup business is profitable when they notice it has the potential to grow. And it’s a decision that will benefit them in the long run. Although investing in new companies can be risky, the rewards are potentially big. Now let’s see more specific reasons why investors invest in unprofitable startups.
Here’s Why Investors Invest In Loss Making Startups
1. “Unprofitable” means promising?
According to investor logic and experience, going for profitability too early usually means limiting growth. An extensive customer base needs to be created, and market research needs to be conducted as well. In certain exceptional circumstances, if the business is exhibiting greater profit in the beginning, something could not be right.
Investors don’t walk away immediately when a company is losing. They carefully consider the future of the business before making any decision. A lot of investors don’t find alternatives like mutual funds and savings accounts lucrative and switch to other options with higher return opportunities. They notice that these startups have the potential for the future, despite the fact that they are not making any profits right now. The promise of future growth attracts investors to fund businesses that are at a loss.
2. Unprofitable businesses can still make money
Investors can still make money from unprofitable companies. VCs frequently sell their stakes and often go ahead with mergers and acquisitions.
3. The brand’s value
Another very good reason why investors invest in unprofitable businesses is the brand value of the business. Some of the biggest examples are Paytm and Zomato. These loss-making companies managed to raise funds only because of their brand value. Uber is also another example. As of recently, Uber has not made much profit. However, suppose a venture capitalist still invests in Uber. By doing so, the investor gets the chance to benefit from it. How? Well, because of the well-known name of the brand. Usually, startups market themselves in specific ways. They can also become relatively more popular than conventional businesses. Most of the time, investors tend to be interested in brands that are making no profits but still raising money. In that case, they bet their money on that brand value.
4. Besides Financial Gain, There May Be Other Motives
When investing, profit is often one of the last things that investors think about. However, most VCs choose startups based on the industry they specialize in rather than the startups themselves. For example, a healthcare-focused investment company may seek market dominance by investing heavily in as many healthcare-related companies as they can. This reduces the amount of money and time their rivals can make from the market. This strategy has the potential to raise the value of their portfolios, which is typically more significant to investors than financial gain.
5. Recovering money
A lot of investors invest in unprofitable startup businesses because they can recover their money even if some loss-making startups blow up. Short-term dividends are one way in which shareholders (owners) might be compensated for their investment in a business. The stock price may also rise owing to increasing demand, and all signs point to investors being motivated to buy shares in this kind of situation.
In the hopes that it would someday turn a profit, some investors may be ready to purchase shares in a firm that is currently losing money. Since they are ready to invest when others are not, these investors—often referred to as “value investors”—have the perception that the business has untapped potential. Investors see it more like gambling intended to back up the net investment gains.
6. The startup’s vision and mission
Some investors focus more on the vision and mission of a business than on the profitability aspect. They invest because they believe in the mission and vision of a startup, despite its making profits. For example, many investors are interested in investing in tech startups. Most startups, particularly tech startups, use innovation as the main foundation to drive success.
So, suppose investors resonate with the business idea and see potential opportunities. Then they do not hesitate to invest their money in the new startup business.
Wrapping Up
There you go! We talked all about why investors invest in unprofitable startups. At first, it may seem confusing as to why they would do so. But, there are quite a few reasons. Now that you have read them, you can understand that their decisions actually do make sense. It is not always the initially profitable nature of the business that attracts investors. There is more to it. Investors understand that although a company is in losses right now, investing in it can benefit them. So, if you are raising funds for your startup, this is good news for you.