It is a significant risk when you invest in startups. But why do many people and organizations continue investing in them? Find out the reasons why investing in startups is a smart financial move.
According to the latest study, 90% of startups fail. In addition, a little over 50% of startups successfully reach their fifth year. More so, the US economy took a beating due to the Coronavirus pandemic. Still, investments in startups showed signs of bouncing back in the last quarter of 2020.
Even with the great risks, venture capitalists, angel investors, and other organizations continue to invest in businesses. So why do people and organizations find it an attractive investment?
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Why Should You Invest in Startups?
Even though it is very a risky financial venture, these investments offer potentially high rewards. Below are five points that will convince you if you are still undecided:
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1. Early Investment Means Greater Rewards
One of the biggest reasons it is a great idea to back startups is getting in early. With the advent of crowdfunding, the barriers of being an early-stage investor have become lower. Hence, the lower overhead capital requirement plus the potential high rewards of an exit strategy is enticing enough to attract investors.
2. Diversifying Your Portfolio
In investment, it is not ideal to put all your eggs in one basket together. To avoid losing big in their investments, investors take steps such as portfolio diversification.
Portfolio diversification means spreading your investments into different asset categories. Thus, it will significantly reduce financial risks. This is where startups come in. Startup investment is substantially different from traditional assets, bonds, and stocks.
Additionally, unlike stocks and bonds, startups are less prone to market fluctuations. Therefore, this type of investment helps mitigate financial risks by diversifying your portfolio.
3. Range of Options
There are startups in different industries and emerging markets. Whether in the field of technology, medicine, and agriculture, startups are looking for funding. You can invest in startups that fit your goals and funding capitals.
4. Impact Investment
When you invest in startups, you not only help in job creation but also in powering innovations. In fact, startup businesses created over 3 million jobs in 2020 alone. For investors looking to directly impact and support job creations in their community, investing in startups is a great path.
In addition, startups usually develop products and services that address the needs of the consumers. When you invest in startups, you are supporting innovations. Thus, startups in green tech, medical technology, and sustainability are very attractive to socially conscious investors. Impact investing is a win-win situation for both investors and startups. Their ideas get their much-need funding while investors get the return on their investment.
5. High Potential for Buy-Outs
Aside from investors, large companies are also looking out for startups. These companies usually buy out startups for two reasons. Firstly, they look out for startups that have the potential to be their competitor in the future. Instead of waiting for these competitors to grow, the large companies will procure the startups.
Secondly, because startups are usually in the field of innovation, they develop new technologies. Large companies who see that they can leverage these technologies to further their businesses will buy them out. Hence, if the startup you invested in sells at a high price, you will enjoy high returns on your investment.
The things mentioned above are just a few of the many reasons why you should invest in startups. However, just like any other investment, startups are high-risks because only a small number of them succeed. Consider the following factors when you start investing in startups:
Higher Risk
There is a high chance that you invest in a company that will fail in two to three years. How the venture performs determines your return on investment.
Wrong Valuations
A common practice of startups is to provide more optimistic valuations of their company. Startup founders usually do this to align their business with the industry. By doing so, they will become more attractive to investors such as venture capitalists, angel investors, and the likes. Therefore, as an investor, you must do your due diligence to study the startup you want to invest in.
No Liquidity
Unlike public stocks, you cannot trade your startup investments. As a result, you have to wait for the startup to go public, be bought out, or be acquired. This means you can’t cash out your investment unless one of these three events happens.
Best Practices When Investing in Startups
Knowing the pros and cons of startup investment is just the first step. Your next step will be knowing the best approaches to investing in these starter companies. The following steps help you maximize returns and hedge risks.
Consider the Industry and Market Conditions
Before selecting which startup you want to invest in, you must examine the industry and market conditions. Consider the prevailing market conditions to know which industries are hotter. It would help if you also studied society’s needs.
Your experience can also become a factor when investing. If you are a doctor, you may have more insights into medical technology startups. Thus, you can make better decisions on which startups to invest in.
Be Diligent
As mentioned earlier, it is always important to practice due diligence as an investor. When planning to invest in a startup, you must study the company’s financial records. In addition, take time to check the startups’ leadership and management team. The more information you have on a company, the better your investment decisions will be.
Always Diversify
As stated earlier, it is wise to diversify your investment. This is also true when you invest in startups. Hence, you should invest in startups that are from different industries, ages, and markets. Diversifying your investment will mitigate the risk of financial loss and, at the same time, maximize potential returns. You can look into investing during the different stages of a startup.
Post-Investment Activities
After investing, there are still things that you can do to help the company. You can monitor the startup’s financial health, mentor its leadership, and even secure a seat on its board. By doing so, you can have a positive effect on the startup that you invested in.
Before You Invest in Startups
First-time investors must understand that investment in startups comes with inherent risks. Although this investment is different from buying and selling traditional assets, you still have to do your due diligence.
There are compelling reasons for you to invest in startups. Whether you want to diversify your portfolio or help in job creations, you can do it by investing in startups. That said, investing in these new ventures comes with the potential for high returns. Lastly, when you provide financial investments in startups, you can contribute to making a social impact through innovation.
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