Investing in startups is a risky business. For every Facebook, there are hundreds of Friendsters that have fizzled into obscurity. Thus, before you are starting to investing in the startup investing scene and becoming a success investor.
1. Startup have a high failure rate
New startups have a 50% chance of making it through their first five years. There’s no real science for predicting which ones will survive as there are a lot of uncertainties involved in new businesses, but the top three causes for startup failure are: no market need, running out of cash flow, and not having the right team according to this study on the top 20 reasons startups fail. So, you should not invest more than you are comfortable to lose because of the high risk nature of startup investments.
There is no 100% way for you to eliminate this risk, however, you should know or check for the background of the company before you going to invest your money, drilling into track records of the founding team, examining if the company can feasibly scale, and investigating the financials. For those investors who are less experience to decide all of these sides, then i prefre that you should invest with an experienced investor who is expert or well versed in the industry of the startup that you are investing in and who can conduct a more thorough due diligence check.
2. Startup investments are illiquid
Startups may not have the capital to pay the dividends until many years later from the time you have made your investment. Thus, the only time you are likely to cash in your investment is when a start-up exits: that is, when it is acquired by another company, or when it goes public. Thus, understanding a startup’s exit strategy is important.
3. Your investment will be diluted over time
Each of the time a company raises funds, it gives up the ownership in a company by issuing additional shares. When a company issues additional shares, the existing investors’ proportional ownership will decrease. This is called dilution. Though your portion of equity may decrease over time, but if the company’s valuation increases, the value of your investment can still increase over time.
It’s important for you to have a keen understanding of all the risks that involved in the investment and how you can use the best way to mitigate them.