Every company has to start somewhere. Even the largest company was once a small business venture. Startups can be an attractive investment option due to high potential returns, but it’s important to carefully assess the risks.
With over 400,000 new businesses created in the U.S. each year, there are plenty of startups to invest in. However, a large percentage of these companies will not last more than a year or two. Investing in these small companies carries a high risk, but it could also lead to a big return due to the high growth potential. Below, you will find the advantages and disadvantages of investing in a startup company.
Advantages
These are some of the advantages that inspire investors to consider startups:
1. More investment options. Larger, more established businesses only offer shares to investors. However, with startups, additional options exist, such as purchasing a convertible note that can be converted to shares later on.
2. Ways to lower your risks. You may, for example, invest in a warrant, a contract that specifies how much you will invest at a certain date, given that the company achieves a certain target. If the startup is not a success, you are not going to have to invest.
3. Most startups on average generally don’t require much funding. This means you could get control of a significant portion of a small company with your investment and might even get to vote on the company’s board.
4. Wide availability. There are startups in many markets and industries. These small companies are a perfect way to broaden your investment through cap sizes and sectors, including emerging markets.
5. Significant opportunity for profit and growth. All it takes is an innovative concept and a good execution for a successful startup. There could be a big return on your investment if the startup that you’ve invested in is doing well.
6. Buy-out potential. A lot of startups are bought by larger companies because they see the startup as a potential competitor or they want to use the technology created by the startup. If the small business you invest in is bought at a lucrative price, you should get a good return on your investment.
Disadvantages
Even with such growth potential, startups are considered high risk investments because a large percentage of small businesses don’t succeed.
Tying up a large amount of your investments in startups places all that money – and probably your financial future – in jeopardy, and there is a high likelihood that you might lose it all. A better way to taking advantage of start-up investments is to assign a fair percentage of your portfolio to start-ups – It’s meant to be the amount you might afford to lose in case the company goes under.
Consider some of these downsides before you invest in a startup:
1. It could be very hard for the company to flourish. Some markets are highly saturated or competitive, and some business ventures simply do not work.
- Take the time to carefully analyze the company you’re thinking about investing in to assess the chances of this startup.
2. The company owner could cause failure. The success of a startup depends, in part, on how hard the founder is willing to work behind the idea.
- Get to know the entrepreneur better to reduce this risk. Find more about the history of their previous business activities. That way you will know how to evaluate a startup company for investment.
3. Unpredictable failure. Even the most ambitious startup may fail due to circumstances that can not be predicted or managed.
- Compensate the risks by including safer investment in the portfolio.
There will always remain certain advantages and disadvantages of safe investment for a startup. Potentially high returns and the possibility to play an important role in the development of a revolutionary product or technology make startups an attractive option. However, these investments carry high risks and you shouldn’t count on getting a return because an idea looks promising on paper.
If you believe that startups are a good choice for you, take the time to search for good business opportunities and allocate a tiny portion of your portfolio to this form of high-risk investment.
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