Tips for Investing in Startups: 4 Risks & Rewards

Startups represent an appealing prospect for a lot of investors, with the promise of an early injection of cash paying out in a big way if a business is catapulted to sustainable success over the ensuing months and years. Of course with the promise of such significant rewards, there are also intimidating risks to take into account, and realities for investors to accept before they go all-in.

Here are some startup investing tips and the main factors at play, both positive and negative, when investing in startups which should help you make the right decision for you.

The statistics don’t lie

When it comes to determining which investments have the best returns, there’s no question that startups can surpass other opportunities, at least in theory.

However, while you might make back tens or even hundreds of times your initial investment if you get in at the ground floor, you also have to accept that the statistics are against you. On average, each year 9 out of every 10 new businesses fail, which makes it sound like this is simply not an investment that’s worth the risk.

Of course this is why a lot of investors choose to hedge their bets and avoid having to make the tricky decisions regarding which startups to back themselves by putting their money into angel investment or venture capital (VC) funds. A degree of diversification can go a long way to protecting you from startup failures.

A good business plan and positive projections should provide confidence

Investing in startups doesn’t have to be as much of a gamble as you might think; it’s all about ignoring the hype and instead letting the underpinnings of the organization, and any performance figures and projections for future revenues, do the talking.

A well constructed business plan, which not only shows ambition, but demonstrates that the founders have an understanding of the market pressures they have to overcome and the kinds of customers they are hoping to win, is a must.

Likewise even if a startup hasn’t yet achieved a profit, you can be more certain of its eventual ascent to profitability if previous revenues and forward-looking estimates are going in the right direction.

Timing is crucial

Another element that can be used to limit risk as well as increase reward when investing in a fledgling firm is the time you choose to strike. Get involved too soon, and you might not have enough information to know whether or not a business has a decent chance of surviving in the mid to long term. Wait too long, and the size of the stake you can afford will be diminished, and your ability to earn mouthwatering returns will evaporate.

Independent investors have to get used to the idea that the only people who usually manage to make very early investments in startups, providing the seed money, are the friends and family members of the founders, and of course the founders themselves. And indeed even though this group stands to benefit most if the startup succeeds, they also take the biggest risks, even before angel investors, so it’s not necessarily an enviable position.

Rigorous research is your responsibility

Last of all, don’t let the pitch material of the startup’s founders sway you and sell you on a project without doing your own due diligence. Researching the market and aiming to scrutinize any claims made about the viability of the business being proposed to you will make sure that you don’t go into an investment arrangement with rose tinted spectacles.

Furthermore, if you don’t understand what a business does, then there’s a good chance that others won’t either, so aim to invest in organizations and industries that you know a bit about already.