Is Investing in Startups a Good Idea? Everything You Need To Know | INVESTEDMOM
According to the Commerce Institute, data collected by the US Census Bureau states that over 4.4 billion businesses are started yearly in the United States. With the vast number of new businesses constantly popping up, it is no wonder people question whether investing in startups is a good idea. Startups are a great investment avenue and can offer angel investors, venture capitalists, and private investors a high return on their investments. While there are plenty of successful startups, early-stage startups fail sometimes, and the investment is risky.
Whether a company succeeds or not is not something that you can quickly identify, especially in the early stage, so committing to an investment is a personal choice. Early-stage companies require that a business get up and running successfully and continue making a profit to finally gain a return on your investment. If the startup companies are successful, your initial investment is quickly returned, and you begin to see big rewards. On the other hand, if a startup business fails, you might never see a return on investment.
While it is difficult to identify whether a startup company will thrive, there are plenty of different things that you can look for to help you understand whether the newly established private company is on the right track. To help you decide whether you should continue with your startup investment, we gathered everything there is to know about the process that startups should follow, what to look for, and the unique risk factors associated when you invest in startups.
What is the Process Involved in a Startup Business?
Successfully launching a business requires business owners to follow specific steps that will attract various investors. Ideally, if you want to become an investor in a company, you ensure that they are following the proper steps rather than taking shortcuts that might lead to complications in the future. Let's explore the steps startups follow and what to look for throughout your startup investing journey.
Innovation
Startup businesses go through the innovation phase, starting a new brand or idea. This process makes or breaks the company. As an angel investor, or investing before the initial public offering, you must identify whether there is a need for the product in the market. Is the product unique, or is there something already in the market that solves the same problem the startup is trying to solve? Suppose there is already something out there that is similar to the product. In that case, you may be better off looking for businesses with unique and innovative products instead.
Business Plan
The business plan should be a blueprint of everything the startup business plans to do to succeed. Those involved in startup investing want to ensure that there is a plan and that the startup is conducting the appropriate research to launch successfully.
Product
Investors want to look at the business plan and quickly identify whether a unique product will give them significant returns. If the startup offers nothing different to the market, consider looking for other investment opportunities.
Operations
A good investment requires a startup that follows operations and successfully plans for various situations. This step of the process ensures that everything is on track and that the development of the product is going smoothly. If operations within a startup are not running effectively, investors should stay away from this company.
Market analysis
Market analysis is essential and identifies the target market. This process identifies all details regarding the target market, including the size, growth potential, and demographics. Investors want to ensure that the startup business completes appropriate research that helps them develop an adequate market analysis.
Finances
As investors develop their investment strategy for the startup companies, they identify any financial projections, including income statements and balance sheets, that quickly help them gauge where the company is headed financially. They also want to understand how much revenue is needed to cover the startup costs.
Secure Funding
This part of the process is where you would come in if you decided on a promising startup. Startups must secure the funding to get their business plans rolling, including financial backing to help them from the beginning of their businesses.
Businesses can approach different types of investors to fund their startups. Depending on your financial situation, you can invest in startups differently.
Friends and Family
Friends and family typically fund startups from the beginning and contribute to developing early-stage companies. These types of investors don't necessarily invest for an exchange in equity and might loan or gift the finances.
Angel investors
Angel investors are usually individual investors who invest in startups with their money in exchange for equity. As an angel investor, you can guide or provide mentorship to the startup business aside from the finances.
Venture Capitalists
Venture capitalists are professional investors, including venture capital firms interested in investing in early-stage startups with high growth potential.
Hire a Team
Aside from implementing procedures to run a startup succesfully, startup businesses need to hire a team of successful individuals to back up the startup. Many startups need to remember that they need plenty of employees to help ensure the startup's success. Investors want to ensure that the business has the people it needs to maximize its potential for success.
Attorneys
Attorneys are essential, and before investing, investors want to ensure that a startup business team is full of professionals to help avoid liability or potential tax problems.
Financial advisors
Financial advisors guide startup founders and the management team toward making the best financial decisions for their companies. Investors want to ensure startups have someone on their team who understands finances to ensure their startup investment is in great hands.
Insurance
Another thing that investors look for in startups is whether they have insurance. Have they taken the time to protect their companies in the event of any accidents or legal issues? Investors are more likely to invest in startups that protect their bottom line.
Legal Business Requirements
While expanding investment platforms and portfolio diversification is tempting, investors must ensure that startups meet specific legal business requirements.
Business License
Investors want to ensure that startup businesses obtain proper licensing requirements from the state or local governments. A startup can only operate legally with a license, so investors must verify it before investing.
Federal tax numbers
Investors also want to ensure startup businesses have their Federal Tax ID numbers. This number is essential for completing various business transactions, including filing taxes and opening bank accounts.
Trademarks
Investors will more likely invest in a startup that has taken appropriate measures to protect its products and business. Startups that show clear ownership of their products are more likely to receive early investors.
Regulations
Startups must ensure that they comply with all the regulations and laws for their product. Doing so promotes responsibility, and investors are likelier to invest in startups that follow the appropriate restrictions.
Contracts
To show their commitment, startups should provide investors with the appropriate contracts for their business, including those with customers, suppliers, and various partners. Rather than going into the investment without knowledge of the commitments, promising startups provide investors with everything they need regarding contracts.
High Risk Means High Rewards
Investing in startup businesses offers plenty of rewards for investors besides financial gains.
Significantly Large Returns
While there is potential for significant returns, startups, especially early-stage businesses, don't see a return on their investments until after the company takes off. Once this happens, though, there are significant returns for investors, and many investors quickly realize that startups have the potential to grow rapidly.
Support New Business Owners
Investors expand their investment platforms and become a part of the development process as they support new businesses. This reward is unmatched, and helping other business owners throughout their journeys allows investors to give back to the community while benefitting from their success.
What are the Risks of Investing in Startups?
Startup investments are risky as businesses still need to develop their successful record. On top of that, there are many startup failures, and investors lose their money in return. Additionally, because startups are relatively new to the business, it can take a long time to see a return on their investment. On top of that, there are plenty of fraud risks associated with multiple startups, so investors must tread lightly when investing.
Because startup businesses are so new, there needs to be adequate guidance to make financial decisions for investors. Investors decide on their own how much to invest and with whom, and while other investors are available to answer questions and bounce ideas back and forth, the ultimate decision lies solely in the hands of the investor. Competition is very high, which also adds to the risk of investment. This is why unique products that solve problems are essential to avoid startup failures. Finally, ensuring that there is a demand is crucial for startups. Without the demand, the risk of investing in startups increases.
Final Thoughts
While investing in startups is an investment avenue that isn't for everyone, it can be a gratifying road to go down. If investors take the time to study and learn about a startup they’re considering investing in, the information they need to make their decision is out there.
Even though it is risky, investors can prepare and ensure they are as knowledgeable as possible about investing in startups. Whether they want to become angel investors or support a venture capital firm, individuals benefit from enhancing their knowledge about startup investing. Sign up for Invested Mom's course to make the most educated choice about investing in startups today!
Meet the Author:
Inge was born and raised in Cape Town, South Africa, and moved to Canada in 2010 looking for a better life. She always had an entrepreneurial spirit and started her first side hustle when she was 9 years old – selling fudge at school during lunch breaks.
It wasn’t until much later that she realized that saving isn’t enough to get ahead. She was always very interested in real estate, but saving up for a down payment was grueling and slow, and the demands of life kept getting in the way.
She started investing in herself and upgrading her skills while learning how to invest. She quickly became debt free and compounded her money at a staggering rate.
It wasn’t until she became a coach that she realized how significant an impact she can make in people’s lives by sharing her journey, learnings, and processes.
So here she is, advocating for everyone who is invested and wants to build their wealth, especially the mommas!