Risks In Investing In Startups

I have been investing in startups for many years. Usually, I invest in the early and very early stages of startups. This investment has long been considered a high-risk. Although with the right approach, as practice has shown, it can be very profitable.

Why is it considered highly risky?

According to statistics, over 90% of projects do not survive to exit. Investors tend to lose almost all of their money. Therefore, you need to invest so that with such a probability of winning, you remain in the black.

Investing in start-ups refers to alternative investments with the reputation of high-risk, not very clear, illiquid, and are not transparent investments.

Many people don’t understand how to do this, as they are not professionals, and therefore they lose a lot of money.

However, recent events have shown how low-risk assets can turn out to be high-risk. Sales and rental programs we have recently seen in the real estate market have fallen dramatically. Many projects became increasingly unprofitable. For example, with commodities, oil had negative prices. Investors received huge losses, where it would seem that profits were supposed to grow.

Therefore, I would not say that venture investment is much riskier. Experience shows it is a normal class of investment. The principal thing is how to invest correctly.

What do you need to do to achieve good profitability in this market?

You can invest by yourself or with a trusted manager. Perhaps we will discuss the topic of choosing a manager in the next article, but for now, we’ll focus on investing independently.

First, choose a clear investment focus, preferably in a field that you know. To invest in a startup, it is not necessary to know all the subtleties of technology, but it is advisable to be able to understand what the project’s goal is. You must be able to convincingly tell yourself why you want to invest in this particular startup. You may think of geography as well to determine a clearer focus. Some people want to invest in projects that are closer to home, some in the English or German segment, etc.

Then you have to choose what industries you want to invest in. Usually, investors draw a circle, where they note industries that are interesting for them to work with or not.

The business model and size of the market are also important. Sometimes you can be shown beautiful pictures and interesting solutions, so you immediately want to pull out a checkbook. But it turns out that the technology is already being made by hundreds of other companies, or this technology is beautiful and awesome but it does not have a specific market application. And when you start speaking with the founders, they say that they will have 10 lines of sales and 100 types of products, but in reality, this means they can’t find their market.

Also, you need to find a team you would want to work with. Your ambitions and goals must be one.

There are deeper methods like due diligence that could be performed, but at the earliest angel stage, there is nothing to check except visually.

After you have taken all of this into account, then you can consider investing.

However, remember what we talked about at the very beginning. 90% of projects do not survive to see the exit. Projects do not always fail because they are bad or their teams are unqualified. Sometimes another startup completes a project faster and captures a huge market share. Take travel, for example. Market conditions have changed, now a large number of travel startups have gone bankrupt just out of the blue.

Therefore, in addition to choosing the right startup, you need to look at creating a project portfolio. To do this, you need to develop your portfolio strategy. You need to invest in numerous projects. I usually tell beginners to have a minimum of 10 projects to be more or less to have a sustainable portfolio. If at least one project is a breakthrough, you will make good money. But if all projects are neither fish nor fowl, half of them will fail, half will succeed. You will earn in the best case, and in the worst, you will lose. Hence, besides a careful selection of the project, it is necessary to have a sufficiently diversified portfolio.

After you invest, it’s good to have a connection with these projects. You will have minimal impact on them if you are not a professional investor. But it’s good to get some information, keep your finger on the pulse, and, if possible, help.

Experience shows that double-digit profitability is real if you have a sufficiently diversified portfolio. And if you enter and exit new projects from time to time and you have a diverse portfolio, you can reach high profits.

Nowadays, you need to keep in mind that when you enter projects at an early stage, the exit will be later. Some projects can last for five to ten years. You should never invest your last bit of money or borrowed money. This increases the risk, because such projects are an illiquid asset, until the re-signing or exit rounds. It is necessary to determine the amount of money you are ready to allocate for investments and the size of your portfolio. Do not expect quick cash out. It may happen but generally you will need to wait for several years.