It is important to be able to identify and address startup investment risks before making an investment. Here is a breakdown of the main types of risks you should be aware of.
Many angel investors have found a startup’s founding team to be one of the main ingredients determining the performance of the company and hence their investments.
Regardless of how promising the product is, there is no guarantee of broad customer demand for a company’s offerings, especially if competitors offer existing close substitutes, or consumers may not be ready for the product’s level of sophistication.
Different types of instruments (preferred equity, common equity, convertible notes) all have different inherent risks unique to their structures and natures that you should be aware of before investing.
Given the highly volatile nature of startup investments, the entire amount of your investment will be at risk. The potential for a total loss of capital is high for many startup investments and you should refrain from investing unless you can bear the entire loss.
Since many startups have a high potential for disruption and venture into emerging industries, there may be some regulatory challenges involved in their sectors or possible issues on intellectual properties.
The company and/or its suppliers’ locations may be sensitive to natural disasters, season volatility and/or pollution problems that could disrupt operations.
WHAT QUESTIONS SHOULD I ASK?
- Is this a good fit for my preferences and priorities?
- Does this startup have a large market and a strong market strategy?
- What stage is the startup in, and what is its valuation?
- What is the financial outlook?
- How well validated is this product and what traction does it have?
- How strong is the management team and can I work with them?
- Is the company scalable and sustainable?
- What potential exits are there and will they provide the returns I need?
- What do other investors say?
SO WHY IS THIS IMPORTANT?
Assessing the risks should always be a priority before you make any investment, especially for assets subject to high levels of both growth and potential failure. Knowing what kinds of risk you face could also help you with leveraging them to minimize the detrimental effects.