All That You Need to Know About Investing Money in a Startup
About fifteen years ago or so, funding a startup used to be a pretty grim prospect. However, with the emergence of different funding models and platforms, things have really started to change. One of the first services to really help startups get off the ground was Kickstarter and its crowdfunding approach.
Nowadays, there are plenty of different startup funding options, which provides entrepreneurs, as well as investors, with more flexibility. The ease with which you can invest in a startup nowadays is phenomenal. And if you are thinking that is the worst time to invest, you would be wrong, because there are tons of startups worth investing in even during the pandemic.
This is important to know because 58% of startups start with less than $25,000 at their disposal. So, we’ve established that it’s easier to invest in a startup than it was ever before and that you can do it despite the pandemic. In fact, there are plenty of delivery services, eCommerce, and online tutoring startups that have thrived in this difficult time and will continue to do well for quite some time. However, there are still plenty of other things you need to know regarding your investment in startups. Let’s look into them.
Research Startup Founders
Even if a particular startup idea might seem like a winner to you, it still has to travel a long road before it can reach the market. One of the reasons for that is the fact that many products and services, regardless of how great they are, go through several different versions and iterations before they find their place on the market and their target audience. And given that the vast majority of startups never become profitable or go belly in the first five years, it seems like a pretty risky endeavor. What you need to be looking at aren’t the idea or the product, but the person running the entire operation.
You want to make sure that the people running the startup will be able to find the right solution. What you can do is look at their track record, as well as their professional background. For example, you can check out the company they have worked with previously or other startups that they have managed. Another valuable piece of information would be their education, which can indicate how knowledgeable they are in a particular field. If they have relevant experience and skills, plus their idea is good, then their startup should be your top pick.
Don’t Follow the Masses
If you happen to see a lot of people investing in a startup, don’t just follow everyone else. Just because a startup is popular, that doesn’t in any way mean that it’s going to be successful and profitable. Again, what you need to do beforehand is do your research, otherwise, you may end up losing your hard-earned money along with everyone else, which doesn’t exactly sound comforting. Try and figure out why some startup companies succeed while others fail. In case you feel like this is way beyond your skill set, don’t worry, because there are still ways of finding out what you need to know.
You can go online and learn more about investing, as well as how the market works, which startups are currently in high demand, and so on. Furthermore, you can seek advice from other investors, financial experts, or you can even contact someone in the startup you want to invest in and acquire more relevant information. We know that the comparison is pretty blunt and cliched, but if everyone else jumped off a bridge, would you do the same? Of course not, and it is the same with investing in startups. Mind you, you can invest in a popular startup, but for the right reasons, not just because everyone else is doing it.
Choose Startups in a Domain You Are Familiar with
If you don’t want to bother to do additional research and learn all the ins and outs of a particular niche, then you can make your decision easier by focusing on startups that are in the niche you are already familiar with. For example, if you already have experience working in the restaurant and foodservice industry, then you will have a fairly easy job of analyzing food delivery startups. You already know how the market works, and since you may have done deliveries in the past, you know what the customers expect from a food delivery service.
Another thing you should pay attention to when choosing a startup to invest in is its ability to be scaled up. Of course, you want the business to be able to grow to the point at which you will not only be able to get the money you’ve invested back, but also make a profit. The more you know about a potential startup and its niche, the more you will be able to project its success. It’s one of the ways in which you will be able to minimize your risk as an investor.
Don’t Put All of Your Eggs in One Basket
This is one of the most common mistakes all beginner investors make. They come across a startup that appeals to them, and they decide to invest all of their savings into that business. However, in case that startup goes belly, as most startups tend to do, they may end up losing some or all of the money they have invested, with no chance to recover it. Instead, consider investing in multiple startups. This will increase the chance of you getting a return on your investment, in case of a liquidity event or if the startup gets acquired by another company.
Again, try and stick with startups in the niches which you are familiar with, as well as those which are run by founders whose track record and leadership skills make it more likely to succeed. Also, it may take a while before you are able to see any return on your investment because investing is a long-term game. You may even be looking at years before a startup is able to start making any real profit.
Avoid Investing in Risky Industries
There are plenty of businesses that can help you make a fast buck, but not without their own set of risks and problems. For example, as of 2019, a lot of investors have been putting their money into startups that deal with cryptocurrencies or even marijuana. It’s a high-risk, high-reward type of situation, and we can even say that making a profit is the least of your worries here. How so? Well, even if you are able to make a profit, the laws which govern this type of business are not the same in every country. For instance, if you want to invest in legal marijuana startups, you can expect the company to have issues when it comes to banking, because many financial institutions don’t want to do business with them, or they are prohibited by law.
And while cryptocurrencies are more “legal” in that sense, authorities and policymakers are still trying to come up with ways to govern and regulate cryptocurrencies. Sure, it may seem like an open buffet right now, but you don’t know what might change in the next couple of years. If you want to invest in something more stable, perhaps you might want to look into startups that deal with real estate, because the risk is lowest in that industry.
Do Your Market Research
This is arguably the most crucial point of them. Before investing in any kind of startup, you need to assess the situation in the market. This means analyzing if there is a need for a product or service offered by the startup, as well as how much competition there is out there. But, even more importantly, the market needs to be large enough so that the company has room to grow. Last but not least, it needs to have a competitive advantage. This is especially important in smaller or limited markets, where businesses are taking customers from one another, and there isn’t a lot of room for expansion in terms of new customers.
So, opt for businesses that are tackling large markets first, and then work your way down. For instance, if the startup you want to invest in is selling scuba diving equipment, then its market is going to be limited to the coastline for the most part. This means that the market itself is limited, but not necessarily small. What matters here is the company’s competitive edge. It needs to offer something different, but still, that original idea or product won’t matter if the team running the startups isn’t listening to customer feedback or doesn’t have a clear idea about how they are going to market their product. Things are a bit easier if you are tackling a large market, but that also means there is more competition.
Investigate the Financial Side of Things
While it’s next to impossible to predict where a company is going to be in five years, the founders of the startup you want to invest in need to at least be able to show you a detailed roadmap that demonstrates how they plan to make the company profitable. Also, in addition to that, you also need to be able to see how your money is being spent. In other words, you need to make sure they are actually spending your investment in a way that is reasonable and relevant.
First of all, take a look at how much the founders plan to set aside for their salaries. Regardless of how much money they have been able to raise, if they are paying themselves extravagant sums of money, then you probably need to take a closer look at their company or avoid it altogether. If they are paying themselves up to $150,000 a year, there is no cause for alarm, but anything above that should be a cause for concern. Second, you need to see how much money they have been able to raise, and if that money is sufficient to help the company grow and become profitable in the future.
Take a Look at the Legal Side of Things
If everything checks out so far, then you need to check out the company’s legal documents, such as subscription agreement, investor agreement, articles of incorporation, and so on. This will help you understand how a company is structured, and which people are involved, such as the directors, investors, advisors, and even suppliers. Once you have done that, you also need to look at the way any potential returns are structures. Simply put, you’re going to want to know the percentage of the company you will be buying with your investment.
Look for the X-Factor
Last, but not least, you need to see if the startup you plan to invest in has something special about it which can’t be easily quantified. For example, have you ever met someone with whom you have nothing in common with, at least on paper, but you end up connecting extremely well? Well, you’re going to want to look for that same X-factor when investing in a startup. Something about the company will speak to you, whether it’s a connection you establish with the investors, or their idea resonated deeply with you because it’s something you really believe in. Of course, this should be at the bottom of your checklist, as it is here, once you have made sure that everything else is sound.
And there you have it, nine essential things you will need to know before investing your money in a startup. Use this article as a checklist and invest wisely. We hope that you have found it helpful. Good luck!
This article was written for The Total Entrepreneurs by Joshua Sharp, a writer from Essay Writers UK.