Investing in startups can give you a front-row seat to various cutting-edge projects. Adding a startup to your investment portfolio can also serve as a valuable diversification strategy. Startups often involve substantial risks and potential rewards, which can help mitigate the risk of your portfolio. If you’re now wondering how to invest in startups, you can start by reading this article.
Understand the Risks Associated with Startup Investments
Like any investment, investing in startups also comes with risks. Not only do startups have more volatile share prices than established companies, but they are also more likely to fail. 90% of startups fail, and 10% of startups fail within the first year.
Startup investment also comes with illiquidity risk. Once you allocate funds to startups, you should expect them to remain tied up for an extended period, as selling your investment is not readily feasible.
Assess Your Investment Goals and Risk Tolerance
Now that you understand the risks associated with startup investments, you can decide if they suit your investment goals and risk tolerance. Typically, investing in startups is recommended for investors with a high tolerance risk to generate substantial profits. However, startup investments may still align with different goals and risk profiles if you diversify your portfolio by geography, industry, and financing stage of a startup.
Educate Yourself about the Startup Ecosystem
Understanding the startup ecosystem is crucial to help you make informed investment decisions. Most startups need reliable partners to improve their operations, so they usually receive help from incubators, accelerators, and venture capital.
Incubators primarily provide support services such as access to necessary infrastructure, network resources, and general assistance. So financial capital and funding are not part of the support offered by incubators. During this phase, startups are usually in their less established condition as they’re still trying to develop ideas, concepts, or products.
Unlike incubators, accelerators ideally come into the picture to expedite a validated venture’s growth and market penetration. They focus on supporting early-stage startups that have already demonstrated the feasibility of their product by creating a minimum viable product (MVP) and testing it in the real market with actual customer purchases.
Meanwhile, venture capitalists are separate legal organizations focusing on developing the startups they are involved in. Their primary objective is to accelerate the growth and scaling of these startups, positioning them firmly in the market and achieving significant profitability and return on investment (ROI) when they are sold.
Besides incubators, accelerators, and venture capitalists, you will also find angel investors in the startup ecosystem. An angel investor is an individual with substantial wealth who can provide significant capital to a startup. They focus on providing financial support to startup ventures in return for a stake or ownership in the business.
Conduct Due Diligence to Invest in Startup
Doing your homework before investing in startups is highly recommended, meaning you should do plenty of research before allocating your money. You can try answering these questions to decide if a startup is a good investment:
- What do you know about a startup?
- Does the startup have the expertise they need to operate well?
- Is the startup’s team passionate about their idea?
- Why this idea? Why now?
- How big is the potential market?
Engage with Startups and Supporting Founders
When you decide to invest in a startup, you’re not solely investing in the company itself but also the team leading it. Startups are usually established by enthusiastic and determined individuals devoted to ensuring their company’s success. Engaging with the team behind a startup and its supporting founders will give you access to what’s going on behind the scenes while ensuring they have a clear vision for the business.
Risk Management and Learning from Failures
Even the most well-performed startups come with some risks, thus risk management is a no-brainer. Take the time to learn about the risks specific to the startup you’re investing in, so you can take appropriate actions to mitigate them. Even if the plan goes sideways, you can always learn from your failures and make better decisions for your next startup investment.
When you decide to invest in startups, do your due diligence first to make careful considerations. You must understand the risks associated with startup investment, educate yourself about the startup ecosystem, assess your financial goals, and develop risk management. Since startup investments are highly volatile, seeking professional advice when entering the startup investment space is advisable.