It is one of the most exciting investment options of the times we live in. The word venture which is now synonymous with the word start-up is being visualised as a separate investment category altogether.
When you invest in a start-up or a venture, you are either buying an equity stake in the company or lending it money at a very early stage in the company’s existence.
There is no standard or established financial metric which you can rely on, to make your decision.
Hence, whether you are an equity investor or a lender, the risks are not commensurate to buying listed stocks and bonds. New ventures inherently come with wider and sharper risks.
Risk of the unknown
The foremost risk is that it’s likely to be in a business that is not yet tried and tested.
For example, a decade or so ago when app-based cabs were a nascent industry, investing in that start-up idea would have required you to understand the nuances of a business that hitherto was not in existence.
Investing in a business opportunity that is new requires a unique foresight that you may or may not have.
Ultimately, you will either rely on familiarity with the promoter or your gut instinct. Or it is the promise of money multiplying many times over or just faith. Whatever the reason, it cannot guarantee success.
In the ideation stage, where promoters seek support from venture investors, it’s hard to assess success. Firstly, you may not understand the business dynamics at all as it is a new age industry.
Secondly, while the idea may be good, the execution could be sub-par, but you would not be able to tell in advance.
This risk of not being able to execute what was a fantastic idea on paper is very real and pulls down many a promising venture.
A lot of initial ideas are also borrowed from existing businesses in the space.
For example, there are several online dating apps looking for funding. Unless there is something concrete and unique in the next similar idea, even successful execution can land it in trouble.
Risk of no market exit
The money you invest in a start-up cannot be redeemed or withdrawn until there is a formal initiation for re-funding or stake sale.
Unlike your investment in listed equities and bonds, which can be sold in the secondary market via the exchanges, you will have to hold on to your start-up investment.
This can be till the start-up itself is ready to give you an exit. This lack of liquidity is also a risk for investors.
Keep in mind
Investing in new ventures and start-ups requires a risk-taking ability. This has to be far superior to that needed for investing in listed entities. You have to assess the opportunity very minutely. Invest only a very small portion of your available surplus and expect only 1 in 10 such investments to deliver your expected return.
If you don’t have the ability to do the research or are unable to diversify widely, it's best to take on this category via managed funds. These can be in the form of AIFs (alternate investment funds). Here the fund manager will get into all the details and create a portfolio of start-up companies to invest in. Out of a portfolio with 25-30 companies, 2-5 ideas are likely to be multi-baggers. This, however, takes a lot of time to arrive at. This is because it needs well thought out investment ideas and the underlying risks still run high.