10 Tips for Investing in “Headed” Startups
We are living an exciting moment and in our daily environment the old paradigms coexist with the new ones. In the current economic context there is a boom in entrepreneurship with the emergence of new disruptive business models based on technological advances and the acceleration of banking disintermediation (partly as a result of the bad image during the crisis).
Investment returns are at historic lows and investors must assume high levels of risk if they want to achieve higher returns (stock market, hedge funds, etc.). In this complex context, the need to build up personal investment portfolios arises. These will allow us to maintain our standard of living when the time comes to retire.
Assuming that we must constitute our own investment portfolio and requiring an adequate return, we will have to incorporate alternative investments (other assets different from the traditional ones). One of the star assets in alternative investment is the Capital Investment of Startups, recently created companies with a high technological component and very high growth potential. But this type of asset, which can represent a great opportunity, also has a high risk component.
We must assume the need to build our own investment portfolio if we want to maintain our standard of living in the future. Investment in the capital of startups can be one of the “star” components in this portfolio.
10 Tips to invest in startups minimizing risks
At Fellow Funders we offer you these 10 tips to avoid taking unnecessary risks in your first investments:
- Understand Pain and Demand. When you are facing a new business, you must understand what pain or need you are solving in society, and how important it is for consumers. This factor is key when starting a business. But you must also be clear about the expected demand. Do not be told about percentages and segments, but about people with names and surnames.
- Know the risks that can affect your investment. It may seem obvious, but unfortunately, when investments are made without the necessary support from professionals, the different scenarios in which the investment enters a comfort or risk zone are not usually well thought out. It is also important to know what specifically affects your investment, not only at the micro level but also at the macro level.
Diversify your portfolio and use the help of professionals if you want to optimize your StartUps investment portfolio.
- Check that the Accounts are consistent and understandable. Before making the investment you must know what the situation of the company is, and understand what debt it has, how it has behaved, what its metrics are, etc. You must also understand what the business expects, where it wants to go and how it intends to do it.
- Financial projections will not serve to value the company, but they do help us understand how the management team thinks. High numbers without reasoning do not make sense, but if we see a Business Plan with appropriate metrics and consistent growth levers, we will know that the team is prepared to take the business to the maximum exponent if the market demands it.
- Know how you will recover your investment. It is important that the people who offer you to make the investment clearly explain how you will recover it (it can be recovered via purchase by another major company, dividends, …). Not all projects are investable, nor do all projects fit our risk profile.
- Diversify your investments. You do not need to invest all your capital in one company or in several companies at the same time. It is advisable to invest the planned capital over a period of approximately 12 months and in the most diversified way possible. Making a minimum of 8 to 10 different investments can help us to reduce our risk profile exponentially. Try not only to invest in different companies, but also in different sectors, technologies, etc.
Always be clear about how you can recover your investment, what the Partners’ Agreement is and what it obliges the promoters and shareholders to do. Analyse and understand the financial data and the logic of the projections.
- Do not buy at any price. Always go with professionals who have analysed the real value of the company. Buying expensive or cheap in alternative investment is not earning less or more but it can be the difference between the business having continuity or not. If the company initially sets a very high value for new investors and does not meet their business expectations, it will not be able to access new financing rounds in the future. This will mean its financial collapse and its end.
- Verify the existence of a clear Partner Agreement. It is of vital importance that you know the rules of the game before starting the match (relations between partners, majority regimes, accompanying and exit clauses…). This is key whether business is good or bad.
- Make sure that the Business Models are simple to understand. There are many companies today that rely on models that allow them to monetize (generate income) when they reach certain stages of development and not from the beginning of their activity. In this case the probability of success is much more complicated. If we do not understand a business model it is better not to enter into such investment, and even less so if it is our first investment in alternative financing. Try to start building your portfolio with investments in those models that you can understand in a very simple way.
- Analyse if the human team is according to the business model. The workers in a company are always important, but in an incipient or not consolidated business they are of vital importance. The adequacy of the team in a startup is necessary for decision making. However, it is much more important that the team can have the ability to pivot or modify the business model at a given time. This will cause the seed to germinate. Not all businesses have the same human needs and assessing the needs and suitability of the team is a differential factor that can ensure the success of the company.
- Check the influence of the Competition. When a new business has no competition, we should be concerned, as it is a sign that things may not be as easy as we may think at first. Having competition in addition to confirming that there is demand, can help us understand the levers of growth, and what mistakes not to make. Being the first is often expensive and painful, while being a “follower” is usually a little easier.
Alternative Investment – Fellow Funders
Remember, alternative investment is a good opportunity to diversify your portfolio. You will also be able to participate in innovative companies that will leave their mark on the future of business. However, you have to be aware that they are not risk-free so follow these tips to do so in a professional manner.
It is not advisable to invest more than 10-15% of your total capital in this type of investment and never use what should be your immediate liquidity reserve.