The Small Business Administration have found out that there are about 500,000 new business ventures started annually in the United States alone! However, the biggest challenge facing most small investors is the difficulty to secure funding. This leads them to turn to family, friends, acquaintances or even ‘Sharks’ in their bid to obtain funding. Owing to this growing trend, most of us may find ourselves faced by an opportunity to invest in one or more of these startups.
Startup investing can reward you both personally and financially. By putting your money in a startup business, you are not only contributing to capital creation, but also job creation. Since time in memorial, the influence of entrepreneurs has been immense, and they continue to shape the U.S. economy to date.
Even though picking startups that will produce mind-boggling returns is quite a difficult task, investing in startups offers entrepreneurs a chance to earn returns of 5-100 times on their initial investment. However, to alleviate the risk of losing your investment, you need to do your due diligence on the business you are investing in, the market, the founding partners, and the competitive setting.
Here are the most important guidelines to keep in mind when planning to invest in a startup business.
- Invest in a sector that you are quite familiar with
Having deep understanding of the market that the startup company operates in is one of the best ways to mitigate risk. This knowledge will help you when trying to project the potential success of this business venture. Always make sure that the startups you invest in have a scalable model, so that they can continue growing at a rate that will be able to repay your investment and a return on it.
- Diversify your investment portfolio
The adage of “never put all your eggs in one basket” applies here. In simple terms, we are saying that instead of putting all your savings in one startup company, try to make multiple investments in different niches. This will not only reduce the degree of risk involved, but it will also increase your chances of success. In case of a liquidity incident like an acquisition by another company or an initial public offering, diversifying increases the possibilities of getting back your initial investment with returns. All in all, these kinds of investments are for the long haul, so we should learn exercise patience.
- Scrutinize the performance record of the startup’s founding partners
One of the most fundamental factors, particularly at the beginning of a startup’s life, is the people behind that company. The reason why the founders are this important is because products must be iterated many times before they can fit perfectly in the market. When researching about them, focus on their background -their education and previous companies- and the type of value they bring to the startup company. Like in the book “From Good to Great” by Jim Collins, “It all narrows down to having the right people g in the right seat. Ultimately they will find the right direction.”
- Assess the competitors
It is very important to research and find out anything you can about the other companies your startup will be competing with for customers. Does your product have unique features to that offered by your competitors? How fast can your competitors create something similar? You might also want to check your competitors’ acquisition history so that you can evaluate if they may be interested in acquiring the startup, you want to invest in, in future.
- Study the startup’s monetization strategy
Examine if the firm has a tactic about how they are planning to make money in place. Get yourself acquainted with the several ways the startup up plans to make money. Are they planning to charge for a service offered? If so, is the price of the service reasonable – would you be comfortable paying that price as a user? Make sure you invest in a company with a monetization strategy because investing in a startup that cannot financially sustain itself will only lead to you losing your money.
- Inspect the startup’s financial records
Investigating the financials of a firm is very important because it will help you know where they have put their money. You will be able to see the number of assets and liabilities that they have acquired, and the potential revenue. You should also look at how they are spending money and if it is sustainable in the long run.
- Check the legal documents
Get to know how the startup was formed and how it is structured by reviewing documents such as the articles of incorporation, investor agreement, any by-laws, term sheet, subscription agreement, minutes of previous meetings, among others. Here you will also be able to check the kind of deal you are getting for the sum of money you are investing in the startup.
In conclusion, always follow your instincts when investing in startups. Ask yourself questions like; does the business make sense? Is its location perfect for that kind of business? Above all, you should not consider investing cash that you can’t afford to lose. All the best as you consider investing in a prudent startup company.