Any investment comes with a degree of risk. Blue chip investment is seen as less volatile. Investing in early-stage startups, on the other hand, is a case of high-risk, high-reward.
Not every startup is destined for greatness. There are plenty of examples of startups that delivered captivating pitches and secured substantial investment capital, but ultimately failed to launch, dragging their investors’ money down with them.
The potential and probability of success in investing is a field of study on its own. But anyone with an interest and a commitment to learning can educate themselves on the philosophy and psychology of investing, as well as practical how-to knowledge.
On the same note, here are some terms and definitions related to risk management in early-stage investing.
Losing money is an ever-present possibility. Losing vast sums can and does happen.
When you invest in a start-up, you can lose the entire amount. The company may fail, their exit strategy may fail, or they may never go public.
Take the Australian streaming startup Guvera. The team behind Guvera were able to raise $185 million before its IPO was blocked by the ASX in 2017. Guvera’s IPO prospectus came under scrutiny from ASIC, which unveiled failure to meet legal obligations. Not long after, the company was placed into administration and subsequently entered into liquidation. Guvera’s investors lost everything.
When investing in early stage startups, the company may survive, show profitability, and hopefully lead to an ROI. But dividends aside, you’ll only see a big ‘pay day’ if the company goes public, merges or gets bought out.
If the company does have a clear and achievable plan for acquisition or IPO, you’ll hopefully see that windfall. But it could be 5 years, 7 years, 10 years, or more into the future. You’ll need to assess how long you manage with funds tied up in the company, waiting for them to become liquid.
Lack of liquidity
Illiquid assets can't be converted into cash. Investment funds can be tied up for years. This is another risk factor that investors, especially startup investors, must understand.
Recent years have seen a decline in the number of businesses going public. It used to be that entrepreneurs would dream of their public market debut day, perceiving an IPO as the ultimate reward for years of hard work. Now, many companies choose to remain private to avoid, among other things, the risk and expense that come with an IPO. The rising popularity of equity crowdfunding has arguably made a dent, providing startups with an alternative to raising funds without relinquishing control.
The key to risk management is education. Starting with this Investing 101 series, learn how to conduct extensive due diligence. Lastly, choose reputable investing brokers and platforms that maintain an exacting selection process for listees.