The idea of investing in a startup is exciting and challenging, both at the same time. Given their higher risks, investing in a startup call for more due diligence compared to your other investments (like MFs, Real estate and more). Investing in startups isn’t just limited to accredited investors – anyone can do it, in a variety of ways. As an investor, you may opt to buy into a privately managed startup or into a venture capital fund that invests in potential opportunities, or purchase company shares, or work directly with a local company to buy a percentage of its equity.
Interestingly, whether it’s a traditional family business or a high-profile tech venture, the legal and financial due diligence required of investors, as well as the level of risk, remain the same.
Investments can be made in companies at different stages of their life cycle. A newly started company might be looking for its first round of investment to get off the ground (known as ‘seed’ funding) whereas an established one would have the necessary revenues but needs investors to expand (late-stage) its business.
As an investor, a fundamental aspect of an investment is, you should yourself have a genuine interest in the companies you choose to invest in. And then if the chance of hitting it big with a fledgling company excites you, go ahead with your gut-feel, carefully keeping a few tips in mind.
1. Examine the legal documents.
Experience states that, very often than not, startups are so involved in big ideas for their business, that they tend to skip having their corporate records in order. Verify whether the company is legally incorporated, that the shares are properly issued, and that the leases and contracts the company claims to have, are ratified, preferably via an experienced legal expert. While investigating, review these investments with the mindset of a student. Ask questions with an open and unbiased mind and try to gain as much insight as you can about the idea, the company, the people and the culture in general at that company.
2. Do the number-crunching yourself
As we all know, a startup’s valuation is anybody’s guess. Often, they are vague and arbitrary because of the lack of established revenue. Sometimes, the management team itself might be using a hypothetical value. Do your analysis of what your share is worth. Also, find out how much has the company already raised. If it has fared well on this front in parallel to a reasonable customer base, it indicates a well-run business.
3. Know your risks
Startups require bold but patient investors. Statistical data suggests that a return on investment in a startup can be expected beyond 10 years or so, implying, these investments are high risk. Your investment may not pay off at all in some cases and as an investor, you should be prepared to lose that money.
On the other hand, it might be wise to spread the risk around by helping to seed multiple businesses simultaneously. It may very well happen that one of your investments fetches early returns and pays off those who are yet to yield positive results. It is important to ensure that your other investments are liquid enough to cover you up adequately, to not get adversely impacted if a specific investment takes time to come up or does not come at all.
Another approach to reducing your risk is to consider ‘Lending’ rather than ‘Investing’. If you prefer not to wait long for an investment return (or possibly never see it at all), offer a business loan to a promising startup. This could be in the form of a revenue-sharing arrangement, in which a regular share is repaid to you annually. The risk gets lowered immediately, but then the potential for reward is proportionately reduced too.
4. Meet the Management Team
Just because a particular startup is a popular name in the market, does not imply you too should invest in it. Work to know the founding team at a personal level. After all, a company’s management is one of the biggest predictors of its success. A level of comfort and camaraderie should get built between you and them. The management’s past and present qualifications should be scrutinized carefully and impartially. Even though the company’s owners are from a circle of known people, always make it a point to cross-verify what they tell you. Do your homework and develop a deep understanding of why you think the company is destined for success. This homework might include seeking advice from other investors or someone within the company itself.
5. Don’t bite more than you can chew
Investing in startups is risky – with either big wins or huge losses. Make sure that you’re financially backed up adequately, to lose the amount you’re willing to invest. You may consider diversifying the startups you invest in, but if you’re very knowledgeable in a particular domain, it’s best to stick to what you know.
At the same time, waiting to invest until you feel like you “know enough”, could also impact adversely by making you a fence-sitter and you could miss out on a potential opportunity induced by fear – of risk, of losing liquidity, or simply the fear of making a wrong decision. The younger generation has only seen the effects of one major downturn in 2008. But older investors have seen multiple ups and downs before, and so are more prudent to have stuck with investing in the market. And, fortunately for them, that approach has appeared to pay off. Taking the time to educate yourself can help alleviate the fear that many investors feel when trying to make financial decisions.
Last but not least, overconfidence can lead to damaging your investment portfolio as much as fear could on the other extreme. As such, set some personal targets for investment and return on those investments. And use what you’ve learned through experience to achieve those goals. Even if you aim to take a less active role in your investments, you still need to evaluate the effectiveness of your plan from time to time. All said and done, it is your money on the block.
The Filings.in can help you make the right investment choices. If you would like to get connected to the right set of startups that match your investment guidelines, reach out to us at 044-46315959.