Stage matters for private investments

The Landscape of Private Companies in the United States

The United States is home to a staggering 25 million private companies, dwarfing the fewer than 4,000 public ones. While public companies tend to grab headlines, the private sector offers a vast and diverse landscape, ranging from small local businesses to multinational behemoths like Cargill ($160 billion in revenue), Koch Industries ($125 billion), and Publix Super Markets ($54.5 billion). These large, stable enterprises represent the mature side of private markets. However, when it comes to compelling investment opportunities, the real action lies elsewhere—in the realm of high-growth, venture-backed startups.

The Allure of High-Growth Startups

Venture capital (VC) funding typically targets high-growth companies, often in exciting, fast-changing sectors like AI, robotics, healthtech, and fintech. Startups in this space are known for their explosive growth rates—often doubling in size annually for several years in a row. These growth rates are rare in public markets, making startups uniquely attractive for investors seeking outsized returns.

Yet the landscape is not without risks. Of the roughly 82,000 startups in the U.S. today, an estimated 90% will fail. This raises a critical question for private investors: Is it possible to mitigate risk while accessing the upside of high-growth startups? To answer this, we need to explore a crucial element of startup evolution: growth stage.

Understanding Startup Growth Stages

Startups evolve through distinct stages, raising capital in "rounds" to fuel their journey:

1. Pre-Seed and Seed Rounds: These early stages involve high risk. Pre-seed funding helps founders develop initial ideas, while seed funding focuses on building a minimum viable product (MVP). Companies at this stage are just starting to experiment with their business models. Investors entering at these stages are fully aware that most of their investments will fail. These investors are often referred to as "Angel Investors" if they are individuals investing their own capital, or "Seed Investors" if they are institutional investors working through a VC fund. At this stage, failure rates are significant—60% for pre-seed and 40% for seed. Early-stage investors offset these failures with one major success. The general expectation is that one in 10 investments will produce almost all of their earnings, potentially delivering returns of 100x or more.

2. Series A: The focus shifts to achieving product-market fit. Companies demonstrate that their solution addresses a real problem and resonates with a target audience. The failure rate drops to 35% as companies begin to establish themselves. The majority of investors at this stage are "early-stage" venture capitalists who also recognize that only 1 or 2 out of 10 investments will generate meaningful returns. By now, the startup has validated its product or service and is beginning to expand customer acquisition.

3. Growth Rounds (Series B, C): By this time, investors are almost exclusively institutional venture capitalists writing checks between $2 million and $20 million. The capital raised in these rounds is used to "grow" what was learned in Series A—essentially scaling proven business methods. This might include hiring more personnel, entering new markets, or ramping up production and marketing efforts. Failure rates decline precipitously during these stages, with 15% at Series B and just 5% at Series C. Investors are now betting on execution rather than ideation.

4. Scale Rounds (Series D+): Companies may continue to raise capital in Series D, E, or beyond, using funds to expand in transformative ways. This includes entering new geographies, acquiring competitors through mergers and acquisitions (M&A), or launching entirely new product lines. While most startups will cap their funding rounds after five to eight raises, others, like SpaceX, have continued raising capital well into double digits (estimates range from 20 to 40 rounds). At this stage, the risk of outright failure is negligible—just 1%.

The risk-reward profile changes dramatically as companies mature. While early-stage investments carry higher risks, later-stage startups offer more stability with substantial upside potential. Identifying the "sweet spot" in a startup's growth curve is crucial for maximizing returns.

The Challenges of Investing in Startups

While later-stage startups offer reduced risk, investing in private companies remains complex. Investors must navigate two primary challenges:

1. Evaluating Growth Potential

Identifying startups with continued growth potential is challenging. Factors to consider include:

• Market Dynamics: How is the company's market evolving? Is the total addressable market (TAM) large and growing?

• Competitive Position: Does the company have a defensible moat? How strong are its product-market fit and customer retention metrics?

• Resilience: Can the business adapt to changing macroeconomic conditions?

Private companies are not required to disclose financial or operational data publicly, making thorough research essential. This opacity creates opportunities but also increases risks. Cases like Theranos underscore the dangers of hype and insufficient transparency. Smart investors focus on identifying authentic traction signals, such as growing revenues, customer acquisition rates, and repeat purchase behavior.

2. Understanding Investment Structures

Investing in private companies is more complicated than buying shares of public companies. Key considerations include:

• Share Types: Private investments often involve preferred shares, common shares, or fund interests, each with distinct terms and implications.

• Valuation Multiples: A $100/share offer may seem identical across opportunities, but the underlying terms—such as liquidation preferences or anti-dilution protections—can make one vastly superior.

• Fees and Costs: Private investments may involve management fees, carry, or other hidden costs that can erode returns.

Navigating these complexities requires both expertise and careful analysis. Investors must not only evaluate the company but also scrutinize the deal's structure to ensure alignment with their financial goals.

Finding the "Sweet Spot"

The key to successful private investing lies in targeting startups at the optimal stage of their growth trajectory. Companies valued between $500M and $10B often represent compelling opportunities for individual private investors:

• Lower Failure Rates: By this stage, companies have proven their business models and are generating substantial revenue.

• High Growth Potential: These companies are still scaling and exploring new growth avenues, such as entering international markets or launching new products.

However, even at these stages, due diligence is critical. Investors must:

1. Perform Deep Research: Go beyond surface-level metrics to dive deep into the company’s fundamentals. This includes analyzing customer satisfaction scores, churn rates, and unit economics—how much profit the company makes per customer after accounting for acquisition costs. Additionally, understanding the company’s competitive positioning within its industry is essential. Is it a market leader, or does it face threats from more agile competitors? This information is not always public, so many times, it may be hard to get all the information you need unless you are a VC who is given access to such details. Knowing what data to rely on for any particular company is the goal.

2. Assess Market Conditions: Scrutinize external factors that could influence the company’s performance. These include interest rate trends, inflationary pressures, and sector-specific dynamics. For example, consumer trends could shift rapidly in retail-focused startups, or regulatory changes might create headwinds for fintech companies. Investors should also consider broader macroeconomic indicators like GDP growth and employment rates, as these can indirectly affect private companies’ revenue growth and stability.

3. Understand Exit Options: A clear exit strategy is vital for realizing returns. Investors should evaluate whether the company has a realistic path to liquidity. Is the company building toward an IPO, which could provide significant upside? Alternatively, does it have the potential to attract acquisition offers from larger industry players? For startups, secondary market sales could also be an option. Understanding the timeline and feasibility of these exit strategies is crucial for aligning investments with long-term goals.

The Private Company Advantage

Investing in private companies offers substantial opportunities for wealth creation, but it’s not without risks. The sheer scale of private markets, combined with the high failure rates of startups, demands a thoughtful and strategic approach. By focusing on later-stage startups, conducting thorough due diligence, and understanding deal structures, investors can navigate this complex landscape and identify opportunities with outsized potential.

Private markets may be less transparent than public ones, but for those willing to do the work, they hold a wealth of untapped opportunities. The question isn’t whether to invest in private companies but how to do so intelligently and effectively. Cold Capital is here to be a partner for those exploring the potential in the private markets.