Risks and Rewards of Startup Investing

Anagha S Anagha S
Aug 1, 2022 7 min read
Risks and Rewards of Startup Investing

Startups have taken over the business world since the turn of the millennium. The plethora of them that mushroomed across the world have been successful in finding solutions to the slightest of human inconveniences. The startup culture in fact has completely pressed a reset button over the traditional business environment that prevailed. This change has been reflected in the nuances of investments as well.

Investing in startups is becoming a common affair just like how people used to invest in public markets. Although it is becoming usual, there is absolutely no doubt in the fact that it is a risky walk on the rope. For a startup investment to be successful, it has to pay off well for the investor. At this stage, where only a few startups make excellent profits, it is of utmost importance to be careful while making such investments so as to not lose one's entire investment at one go.

The truth is that hardly 10% of startups generally make it to their Initial Public Offering (IPO). Hence the risk associated with it is immensely high as either the investor will become wealthy with returns amounting up to a thousand times the investment or it can be a complete loss. This article will look at some of the risks and rewards of startup investing.

Rewards of Startup Investing

Risks of Startup Investing

How to Invest in Startups in India?

Rewards of Startup Investing

In today's time, when the startup industry is booming, investing in startups can turn out to be a lucrative opportunity. The following are some of the rewards of investing in startups:

Value of Growth Capital Investment Deals India from 2016 to 2021
Value of Growth Capital Investment Deals India from 2016 to 2021

Dynamic Portfolio

Investing in startups is an excellent way to diversify portfolios to include assets that are of high risk and have higher rewards. Trends of investors show that they invest in multiple startups personally or through a venture capitalist firm to practice diversification. For example, Jeff Bezos has made personal investments and is also actively investing through his venture capitalist firm, Bezos Expeditions in various startups.

Patterns of investments of those who have earned profits through the process show that they invest in multiple startups rather than investing all the money in a single startup. By diversifying investment, the investor can make multiple profits from various asset classes. It also ensures that one does not sink all of the available capital for a single investment opportunity. Diversifying investments also increases the probability of getting better returns.

Outsized Returns

It is true that startup investments are highly risky. But it also means that if the startup ends up doing exceptionally well, it is also highly rewarding. When compared to any other form of investment, an early investment in an innovative startup is the most rewarding one with returns exceeding several times the investment. For example, Peter Thiel was an early private investor of Facebook who invested $500,000 into the firm. Eight years after its launch Facebook offered its IPO after its valuation climbed over $100 billion. Soon after the IPO, Peter Thiel made more than $1 billion.

On another note, if a person had invested in Facebook on the first day of it in the public market, their share would have been quadrupled by now. In order to assess the probability of getting better returns through startup investing, it is highly important to keep yourself updated about the nuances of venture returns.

Networking Opportunity

Startup investment is a great way of building new connections with other investors, founders and stakeholders. It will help in understanding more about the details of investments keeping one along with the latest updates. An investor would probably want to invest in multiple asset classes as the very idea of investing goes by the tagline β€œDon't Put All Your Eggs in One Basket”. The networking opportunity provided by every startup investment is thus, a gateway for excellent networking opportunities which can later lead to further investment opportunities.

Positive Impact on Employment

Every startup investment that one makes is the beginning of a business which has the potential to change the lives of people. Hence investing in a successful startup indirectly has a positive effect on employment rates. Every small investment made in a startup also benefits the local population thus, reaping not just financial benefits for the investor but also economic benefits for society.


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Risks of Startup Investing

There is no doubt in the fact that startup investing is a great opportunity for earning profits. However, the investment may not always turn out to be successful. The following are some of the risks of investing in startups:

Startup Failure Rate by Time in Business
Startup Failure Rate by Time in Business

Unforeseen Complications

One of the biggest risks of startup investing is the unforeseen complications that might occur in the market. Every startup materialises into a full-fledged business if the ideas are innovative and everything is executed perfectly as planned. Yet, there are chances that things might not work the way it was predicted. The economy is tricky and unpredictable and can come up with hurdles of various intensities.

In order to ensure that an investor does not run down the path of bankruptcy by investing in a startup, it is vital to make a prudential decision on how much fund should go into each investment. It is always a good idea to have a backup plan in case things do not work out in the planned way. Having a sound understanding of the startups will also help in understanding the reasons why the business crashed.

Fraudulent Practices

There is always a chance that people get cheated every time there is money involved. Startup investments are no different. Investing in startups that you don’t know much about can be a dangerous thing. Study deeply about the founders, their backgrounds and their plans. Investing is not a blind isolated act. Be aware of the details of the company that you are investing in, and watch their progress closely for any signs of malpractices or misconduct.


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Uncertainty of ROI

The risk factor associated with startup investing is exceptionally high considering the fact that 90% of startups fail within five years of their inception. It also means that the return on investments is also not guaranteed. The risk associated with ROI does not stop there. Sometimes risks are posed due to liquidity issues wherein it takes a longer time than expected to earn a profit. In some cases, it can also be that despite making a profit there won't be much money left after deducting expenses incurred.

Liquidity Issue

Another major risk in startup investing is the issue of liquidity. When you are investing in a startup, it means your money is going to be bound for a very long time. Even if you start regretting your investment, you will not be able to sell it anytime soon.

Conclusion

The very idea of startup investing is a high-risk, high-reward phenomenon. Whether it is going to be rewarding or not is going to depend on a lot of factors including the novelty of business ideas, execution of the plan, customer satisfaction, target achievement, receiving of subsequent funds etc. The one thing that investors can do to be on the safer side is to do thorough research on where the money is being invested and be updated with regard to every minute progress of the firm. Another way to ensure the investor does not lose a lot is not to invest all of the capital in a single startup.

The entire exercise of startup investment has a far-fledged impact on society rather than just the monetary ones. It can change the fate of a family and even society in itself. Hence, doing deep research and investing prudentially can go a long way.

FAQs

How do startup investors make money?

Startup investors make money on the basis of the equity percentage they got in exchange for their investment in the startup.

Can a normal person invest in startups?

Yes, a normal person can invest in startups. One just needs to have the minimum amount of funds available for investing through a private equity fund, VC, or debt financing. Many Angel Investment platforms like IPV even allow people to invest in startups with a minimum investment of as less as 2.5 lakhs INR.

What is the number one reason startups fail?

One of the most prominent reason startups fails is because they run out of cash. Money is the most crucial aspect for any startup to keep growing so when a startup fails to raise new capital at the right time, it leads to its downfall.

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