Startup Investment Risks – Can You Tolerate These 5?

July 13, 2015

5:00 pm

For money to grow it has to be invested. We all know this, but we often jump rather blindly into investments on the advice of those we don’t know well, or on “hot tips” from friends. One of the newest forms of investing comes not in stocks or bonds, but, rather, in startups, during two key times – in their inception (the seed phase) and in their production phase, once they are up and running. It is estimated, from rather valid research, that there about 1,000,000 startups a year around the globe. Of course, most don’t make it; but if an investor happens to have picked one that does, the chances to make a hefty amount of money are pretty good.

No investment is risk-free, but some come with more risks than others. And among the riskiest are startups. Here, then, are a number of risks that you may want to consider before you pump money into a startup venture.

90% of startups fail

This is perhaps the biggest risk of all. The statistics are very clear on this. Only 10% of startups survive beyond 10 years, so the odds of selecting one of “10%-ers” are long. If you do not have the stomach for individual investing, but still want in on the potential to make major profit, then you might consider investing in a private equity fund. These funds invest in a number of startups at a time, banking on the fact that 10% should make it. Your risk is somewhat reduced, because the investments are spread over a number of diverse niches.

The other caveat, of course, is that you will need to be in for the long-term. Most of these funds will exit from a startup at the 10-year point, unless, of course it goes public before that.

Putting all of your investment capital in one or two startups

According to Dan Martell, founder and CEO of Clarity.fm (a company that was created to match entrepreneurs with advisers and angel investors), to be successful, you need to put $10,000 into a minimum of 15 startups at a time, in order to have the best chance of just one making it.

If you can’t afford to do this, he cautions, don’t do it at all. Putting together a small group of friends and/or colleagues who, as a group, can do this, is certainly a viable alternative. Martell himself has personally invested in a number of startups and confirms the 90-10% “rule.”

Doing this on your own if you are a novice

Successful investing comes from experience and study, and beginners in startup investment will most surely fail. The best hedge against this is to partner with another angel investor who has the experience you do not.

Putting in money that you cannot afford to lose or that you cannot afford to let sit for 10 years.

Investing in startups is long term, to be certain. And the chances of your getting your money out before that are almost nil, unless you have an equity position and can find someone to buy you out.

Failing to do your due diligence

This encompasses myriad activities, not the least of which is conducting some of your own research regarding the viability of the product or service, the competition, and some basic market research. Beyond that, do you see the proper skill set among the initial team members, along with a passion for what they do? Passion is a huge factor in success.

Legal issues are pretty critical too – who has investigated the regulatory environment that surrounds this niche, and are there guarantees that no copyright infringement lawsuits do not wait down the road?

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Dianna is a former ESL teacher and World Teach volunteer, currently living in France. She's slightly addicted to apps and viral media trends and helps different companies with product localization and content strategies. You can tweet her at @dilabrien

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