How to invest wisely in a start-up


How to invest wisely in a start-up

“If you just work on the stuff that you like and you’re passionate about, you don’t have to have a master plan with how things will play out.” This is one of the famous quotes by Mark Zuckerberg, the world-famous billionaire and CEO of Meta (formerly known as Facebook). This is so true. Passion and loving what you do is what propels entrepreneurs, sustains them through the good and bad times, and ultimately determines the success of any start-up.

Statistics corroborate the above belief.  In a survey by “Thrive My Way”, 23% of the people state the pursuit of their own passion behind starting a start-up.

Source: Thrive My Way

A start-up is an extreme version of a regular business. It may burn quite a lot of money initially in building iterations of its solution, testing it, and pushing it out in the market without any significant revenues. However, if the solution achieves its product market fitment and starts to gain traction, the upside of a start-up can be massive. Its tendency for growth and profit is usually, in those cases, much steeper than that of a regular business. If you make it, you make it really, really big!

Main reasons for funding start-ups
Source: Verve

Interesting fact: As shown in Verve’s survey above, 42% investors claim that lucrative return on investment (ROI) is their top motivation for investing in start-ups.
Startup investing is a tremendously rewarding as well as learning atmosphere, and people who invest in companies have a strong desire to learn more about new things. The potential to impact society and supporting an entrepreneur are other key reasons to invest in start-ups.
What are the characteristics of a start-up?
A start-up is usually characterized by the following traits:
1.       A start-up creates disruption in an industry: A radical change in technology can change everything. A new product may come along and solve a problem considerably better. So, a new start-up comes along, disrupts the existing trend, and changes the way things are usually done in a specified manner. But it is this disruption that leads to its eventual success.
2.       A start-up has the potential to scale quickly: A promising start-up is usually one that has the penchant to grow exponentially fast. This is crucial for investors. They expect a return on their investment within a few years and a regular business’ slow growth doesn’t whet their appetite. This is equally important for the founders too because a faster rate of growth frequently determines whether they can raise money and at what price. With slow or little growth, it can be really hard to raise money.
3.       A start-up raises a significant amount of money: Typically, sizeable initial investments (USD 250K – USD 2.5Mn) are needed at first to be able to build something great. The solution requires multiple iterations, testing, and research until it finally finds a product-market fit for its target customer segment. This could take weeks or months and yet there’s no guarantee that every solution will find a product market fit of considerable size to make the start-up sustainable. Hence, keep in mind that investing in start-ups can be risky, so one needs to be mindful and aim for the ones that are likely to succeed and offer a very high rate of return on investment. It is always recommended to make a calculated decision before investing in any start-up.
Tip: A background check on the start-up funding of the companies you invest in will not only help you make money, but it will also mitigate your risk. Any investor should be conscious of the risk involved in their investment decisions at all times. If one wants to increase returns and profits, one should be willing to take risks. Remember, with higher risks come higher rewards.
The transformation from a start-up to a sustainable and successful business rests on three pillars: capital, product, and marketing. Venture capitalists, angel investors, and other types of investors invest in start-ups despite the high risks primarily because they believe that one of their start-ups will give them high enough returns that will make up for the losses of the remaining ones.
What factors should you consider when investing in a start-up?
Below is our compilation of the most important factors worth considering in start-ups:
1.   Diversification of holdings and wider availability: Start-ups are an asset class that gives you a wide range of investment possibilities, allowing you to diversify your portfolio and have a portion of it that is not tied to the public equity markets. There are start-ups in many different sectors and verticals. This implies that you, the investor, can make investments in a market niche that particularly interests you.
2.   Familiarization with the Business or Industry: Learn everything there is to know about the start-up’s line of business to make the best decision possible. When start-up entrepreneurs are presenting their business idea, they frequently focus primarily on the advantages rather than the drawbacks. If you are knowledgeable about the sector, you can spot the problems right away and stop impulsive judgments and decisions.
3.   Learning about the founding team: When you invest in a start-up, you invest in the founding team. Hence, it is crucial to research the people you are investing in. It is crucial to understand their background, years of experience, the domain of expertise (and its relevance to the start-up) and educational background. Also, consider whether you would get along well intellectually or at a non-financial level. People who are not entrepreneurially compatible often tend to experience conflict or friction along the start-up’s journey.
4.   Extracting the unspoken details: Startup founders frequently withhold important information when presenting their business ideas. They only share the information with those on a “need-to-know basis,” as their goal is to raise money. It is wise to elicit a lot of information and find out if any other business/institution is investing in the start-up or has previously invested in it. The more questions you ask, the clearer your comprehension will become, and the more knowledge you gain, the easier it will be to avoid risks and awkward situations.
5.   Competition: All start-ups strive to rapidly expand their clientele and take the lead in their industry. As a result, it is crucial to be aware of the existing competitors in the market and be convinced that the start-up you are investing in has a solid and sustainable moat for at least a couple of years in the market or target segment the start-up is in.
6.   Channels of investments: Investments can be made in start-up companies directly, through start-up funds, or through a variety of platforms that facilitate start-up investing. Experts manage start-up funds and bring expert management. They generally have the drawback of being highly priced though. Platforms charge a fee to provide shortlisted companies to investors for selection. It is recommended to choose a platform that offers transparency, has a proven track record of success, and is not overpriced.
What are some of the downsides of investing in start-ups?
When you invest in start-ups, there are significant risks involved. If you’re going to experiment in this area, be sensible and avoid investing money you can’t afford to lose. While investing in start-ups might offer massive benefits, it also has a few pitfalls that one must be wary of in order to avoid unpleasant surprises:
1.     Lack of accessible in-depth information: Your investment won’t be subject to the same stringent reporting requirements as a publicly-listed business because it is a privately held company. As a result, you will have limited access to information on the company’s financial situation. It may be challenging to decide when or whether to invest as a result. Additionally, it may be more difficult to determine whether the company is being valued appropriately.
2.     Longer time frame: Be ready for your money to be invested for a minimum of two to four years. If at all, it can take even longer before you get your money back. ROI is realized only when the next rounds of investments happen. That could happen in the next month, year or maybe even never!
While investing in start-ups can be exciting and dynamic, it is not everyone’s cup of tea. Before investing money in a fledgling company, no matter how promising it may seem, consider your appetite for risk and your tolerance for loss. Choosing which firms to invest in might be difficult with so many new start-ups coming up every day.
However, you may decide intelligently whether a start-up is worthwhile for your time and money by conducting thorough research.
·       Determine whether a start-up is solving an impactful problem first. If it is, the start-up has potential.
·       Consider the team and its history of creating profitable businesses before forming an opinion.
·       Think about whether the exposure to the technology or subsector is worthwhile for your entire portfolio.
Due to their ability to adapt and respond to problems as they develop and their freedom to innovate solutions, start-ups are one of the most promising instruments to address the pressing issues that our society faces today. The start-up ecosystem facilitates the development and market testing of a staggering number of new possible ideas, expediting the process by which even large global concerns can be resolved. Successful start-ups do have the ability to change the world for the better. Even failed start-ups have an impact, particularly through the lessons learned by the founders, teams, investors, and other stakeholders.