Investing in startups means you’re taking significant risks.
But it can be very rewarding once your investments pay off.
The vast majority of startups fail—even if you do your homework, you could end up with nothing in your pocket.
That may be true that’s why investing in startups is not for the faint of heart. Because the majority of new companies or products fail, the risk of losing one’s entire investment is real. Those who succeed, on the other hand, can generate extremely high returns on investment.
Despite the high risks, may still continue to invest in startups. So, what makes it appealing to individuals and organizations?
1. High Risk, High Reward
If more returns and profits are desired, one should always be willing to take risks.
As start-ups are just companies in their early stages of development, there is a chance that the company you invested in will fail! But if it grows and becomes a great establishment, it will have many opportunities to offer and a good amount of monetary benefits, which will be profitable to the investor as it maximizes the amount credited in the early stages.
Investing in start-ups after conducting a background check on their start-up fundings will not only result in profit but will also reduce one’s risk.
But always remember, any investor who invests is and should ALWAYS be aware that investing involves risk.
2. Chance to Diversify Portfolio
Portfolio diversification entails spreading your investments across various asset classes.
As a result, financial risks will be significantly reduced. This is where startups can help.
Investing in startups is a great way for any investor to spread portfolio risk.
Having shares in an unlisted company means that startup returns are often less correlated with market movements, reducing the impact of negative market shocks.
Also, with low entry barriers, no hidden fees, and a diverse range of investment opportunities, equity crowdfunding provides an accessible way to diversify holdings across industries, business stages, and risks.
3. Investment Impact
When you invest in startups, you not only help to create jobs, but you also help to power innovation!
Why? Because startups typically create products and services that address consumer needs. When you invest in startups, you are helping to support innovation.
Both investors and startups benefit from impact investing. Their ideas receive much-needed funding, while investors profit from their investment.
4. Great Opportunities
One of the most compelling reasons to invest in startups is the chance to be a part of something new, exciting, and innovative. While some investors are content to sit back and watch, those who invest in a startup in its early stages are often hands-on, offering advice and perspective.
5. High Potential for Buy-Outs
Aside from investors, large corporations are also on the lookout for startups. These businesses typically acquire startups for two reasons.
First, they look for startups that have the potential to be future competitors. Instead of waiting for these competitors to grow, large corporations will acquire them.
Second, because startups are typically involved in the field of innovation, they create new technologies.
Large corporations that see how these technologies can help them grow their businesses will buy them out.
As a result, if the startup in which you invested sells for a high price, you will receive a high return on your investment.
Of course, if there are benefits, there are also risks! And what are those?
Check out our list of risks below that you need to consider when making an investment in a startup company.
Risks
Investing in startups is extremely risky and highly speculative, and should not be undertaken by anyone who cannot afford to risk the entire investment.
Before making any investment decision, you should carefully consider the risks associated with the type of investment, security, and business.
Investment Risks
- Principal Risks
Investing in start-ups will put your entire investment at risk.
There are numerous scenarios in which the company may fail completely or you may be unable to sell your stock in the company. In these circumstances, you may lose your entire investment.
A total capital loss is a very likely outcome for startup investments. Investing in startups carries a high level of risk, and you should not do so unless you are willing to bear the entire loss.
- Returns Risk
The returns on these types of investments, if they exist at all, are highly variable and not guaranteed.
Some start-ups will succeed and generate significant returns, but many will fail and generate only minor returns if any at all.
You should not invest if you need a consistent, predictable, and/or stable return.
- Liquidity Risk
Your securities may be difficult to sell. Startup investments are privately held companies that are not publicly traded on a stock exchange.
There is also no readily available secondary market for private buyers to purchase your securities at this time. And there may be restrictions on the resale and transfer of the securities you purchase.
You should not invest in any funds that require the ability to withdraw, cash out, or liquidate within a specific time frame.
Business Risks
- Competition Risk
Other companies, some of which may have received more funding than the startup, may compete with it!
One or more of the company’s competitors may offer similar services to those offered by the company at significantly lower prices, putting downward pressure on the prices the company can charge for its services.
If the company is unable to charge the prices it anticipates charging for its services, the company’s results of operations and financial condition may suffer materially.
- Market Demand Risk
While the company believes that there will be customer demand for its products, there is no guarantee that the company’s offerings will be widely accepted in the market.
If the company’s competitors offer products that prospective customers prefer, the company’s offerings may not find widespread market acceptance.
In such an event, the company’s results of operations and financial condition may suffer materially, and the company may be unable to meet its objectives.
- Control Risk
Because the company’s founders, directors, and executive officers may be among its largest stockholders, they have significant influence over the company’s business and affairs and may have actual or potential interests that differ from yours.
The founders, directors, and executive officers of the company may own or control a significant portion of the company.
In addition to their board seats, such individuals will wield significant power over corporate actions that require stockholder approval, regardless of how the company’s other stockholders, including you, vote.
- Growth Risk
A start-up must expand significantly in order to succeed!
There is no guarantee that it will reach this goal. Expansion can put significant strain on the company’s management as well as its operational and financial resources. The company must implement operational and financial systems, procedures, and controls to manage growth.
They may also need to hire more people in finance, management, and operations. There is no assurance that the company’s current and planned personnel, systems, procedures, and controls will be sufficient to support its future operations.
Failure to effectively manage a company’s growth could have serious consequences for the business, results of operations, and financial situation.
Before you invest in startups…
You have compelling reasons to invest in startups. Investing in startups allows you to diversify your portfolio while also helping to create jobs. Having said that, investing in these new ventures has the potential for high returns. And, by making financial investments in startups, you can help to make a social impact through innovation.
But, you must understand that investing in startups entails risks. Despite the fact that this investment differs from buying and selling traditional assets, you must still conduct due diligence.
Listen to our podcast with angel investor Hamish Hughes and learn more about the risk and rewards of investing in startups.
