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When we think of personal finance, we often picture traditional investment vehicles like stocks, bonds, and real estate, occasionally supplemented with conservative assets like gold and fixed deposits. While these are important components of a well-rounded financial strategy, another asset class has been gaining momentum recently - startups. Although not as commonplace as stock market investments, startup investing can be a lucrative addition to your investment portfolio.
Investing in startups involves providing financial backing to early-stage companies in exchange for an ownership stake in them. Such investments are a crucial part of the entrepreneurial ecosystem, fostering innovation, generating employment, and contributing to economic growth.
The appeal
One of the primary reasons to consider startup investments is the potential for high returns. Startups are often in their early stages, and if they succeed, the value of your investment can grow exponentially. While the risk is higher compared to more established companies, the potential rewards can be commensurately higher.
India, positioned as the world’s third-largest startup ecosystem, with 73,000 active startups in 2022 compared to a mere 7,000 in 2014, offers significant prospects for investing in startups. According to an internal IPV analysis, angel investing can yield returns of 27 per cent, outperforming averages of 7.8 per cent for real estate, 11.5 per cent for listed equities, and 6.9 per cent for gold.
Another reason to consider startup investments is diversification. Startup investments do exhibit some correlation with traditional asset classes like stocks and bonds, but the correlation is not overtly strong. This means that if the stock market experiences a downturn, your startup investments may not be equally impacted, or there could be a delay in the effects. This delay can contribute to mitigating the overall risk within your investment portfolio.
Investing in startups can be personally rewarding. Startup investments come with the opportunity to be actively involved in the growth and development of the company. Your expertise, guidance, and connections can make a tangible difference, offering a chance to support innovative ideas and entrepreneurs you believe in. Startup investment provides an avenue to invest in companies actively addressing pressing societal and environmental issues.
A word of caution
Nevertheless, it’s important to approach startup investments with caution. Investing in startups carries inherent risks, and there’s a chance of losing your investment if the startup fails. To reduce this risk, it’s crucial to diversify your investment portfolio. Startup investments are typically illiquid, and you may have to wait until the startup goes public through an IPO, gets acquired, or does a secondary transfer during subsequent rounds of funding to realise returns on your investment.
Negotiating the road ahead
Before venturing into startup investments, it’s imperative to educate yourself about the startup ecosystem. This entails understanding how startups operate, the various stages of funding (seed, series A, series B, etc.), and the associated risks. Startup investments can be riskier than traditional ones, so it’s vital to assess your risk tolerance. Determine how much of your overall portfolio you are willing to allocate to startups and be prepared for the possibility of losing your entire investment in certain cases.
Just as you wouldn’t stake all your capital on a single stock, you shouldn’t concentrate your startup investments on a sole company. Diversify your startup portfolio by investing in multiple startups across different industries and stages. This approach can help spread risk and improve the odds of a successful investment.
Building a network within the startup ecosystem is invaluable. Attend startup events, participate in online forums, and connect with entrepreneurs and fellow investors. Networking can not only help you discover investment opportunities but also provide insights and guidance from seasoned professionals in the field.
Before investing in any startup, conduct comprehensive due diligence. This includes evaluating the founders, market, competition, business model, and financials. Exercising patience is essential, and adopting a long-term perspective is often necessary to realize the full potential of your startup investments.
Angel investing platforms can streamline the investment process by identifying promising startups, performing due diligence, and presenting these opportunities for your consideration. Especially for those just beginning their journey in angel investing.
Incorporating startup investments in your finances can provide high returns. However, it’s crucial to educate yourself, assess your risk tolerance & establish a diversified portfolio. Begin with modest investments to gain experience and be prepared for the long-term nature of startup investments.
(The writer is Partner at Physis Capital)