Risks Of Investing In Start-Ups
Investing in start-ups is no small feat. Investors must do a complete and thorough analysis of the company before embarking on the risk of investment. Take a look at the start-up’s business plan – the one-page business plan and understand their projections for the coming year, their outcomes and goals, etc. That said, start-ups are the future. Investing in them can be very beneficial and sound. We must, however, also look at the risks involved in getting into the start-up business. In this blog, I will highlight some of the risks that you may take on while investing in a start-up business. Before even thinking about investing, you must look at these risks with a very objective mind-set and weigh out if the rewards outweigh the risk or vice-versa.
- Minority Stake
Normally you will not invest a great deal into one company. This means you have invested money that is on a smaller scale as compared to larger investors. This leads you to have smaller equity in the company. This means that you cannot influence the company in any way and you do not have much say in the workings of the business. This can also lead to your securities being treated with a lesser preference as compared to the larger stakeholders.
At a later time after your initial investment, the start-up may require more funds. As a result, more investors will come into the picture. Making a new investment into the business ensures these investors issued securities. These new securities can dilute the percentage of ownership that you have bought in the business.
- Principal Risk
If you invest in start-ups, you are an angel investor. Once you invest in a start-up you run the risk of losing said investment. This is because if start-ups fail, they are not obligated to pay back your initial investment. For most start-ups, losing money is a likely situation because they can’t keep up with other factors that affect the business. This is why it becomes a high-risk investment. It’s imperative to note that you should only invest in start-ups if you know that losing the seed money will not harm your situation in any way.
- Risk of Return
The ROI (Return on Investment) if any, is highly variable and not fixed. Most start-ups don’t see any profits until a few years down the line. Most of the time they are barely able to break even. That is not saying that all start-ups perform badly or at a sub-par level. It’s however important to note that one must not invest money that you may need daily in start-ups. Returns will vary depending on how the company performs yearly.
- Liquidity Risk
Start-ups are not publically traded companies. They are privately held and as a result, selling your securities can get very hard. Further, there is no secondary market available for anyone to buy off your securities from you. This means that one must think twice before investing. Make sure you put in money that you may not need for a good amount of time.
Investing in start-ups comes with great risk. The trajectory of start-ups is not good. Most fail. It can be due to several reasons. It can occur due to the customer base not being as responsive as predicted, the product could be subpar, the competition too intense for a new company, etc. Even if after all this you still want to invest in a start-up, you should prepare yourself to run the risk of losing the whole investment.
Sometimes, the people working in these start-ups may not be ethical. They can entrap investors into a scheme, stealing all the investment money in the process. This is another reason why angel investors must vet the company and conduct thorough research before going into business. A careful review of the fine print is a must.
To Sum Up
I have listed out the key points to keep in mind before thinking about angel investment in start-ups. Don’t however, let these risks deter you from investing. A start-up always deals with a niche market and as a result, the product or service they come out with can be very unique. If you believe in the cause of the start-up as well as how they plan to carry out their process, you should go ahead and invest.
The best way to decide if your start-up does require an angel investor or start-up funding is by having a complete business plan. Your business plan should also include a One-Page Business Plan. I have developed a one-page business plan for all start-up founders and entrepreneurs. This business plan helps you ideate what you would like to achieve the following year as well as the activities you are willing to give up. It helps you to understand the shortcomings of the previous year as well.
About Devansh Lakhani
Director of Lakhani Financial Services, and a Chartered Accountant, he helps start-ups raise funds from his network of investors. He guides and advises start-ups to scale up by providing efficient sales, marketing, team building, and business management strategies. He has executed fundraising by block deals on the stock exchange and conducted IPOs and right issues on the SME platform to the tune of over Rs. 50 Crore. He is currently working with start-ups from various sectors to help them channelize their business models and investments.