The 7 Largest Risks of Investing in Startups in 2019
Investing your hard earned cash can be a great idea as long as you properly understand the risk of the specific investment. Each startup has a unique risk profile that you need to understand before making a seed investment. Below you’ll find the risks you need to consider before making a startup investment.
1. Valuation Risk
To make a profit on a startup investment, a future investor has to value the company at a higher valuation then the valuation you invested in. A company raising money could set their valuation at $5 million when their true value is $3 million. This would mean that you’d lose a percentage of your money as soon as you invest. As an investor you need to make sure the valuation of their company is fair. To get an idea of how much a company is worth view the financials on their page. One quick way to get an idea if the valuation is accurate is to see how much money the company has raised so far at that specific valuation. If the company has raised a large percentage of their goal it is a good signal that other people believe the valuation is closer to the real value.
2. Company Specific risk
This is the risk characteristics of the specific company you are investing in., a competitor coming into the market, internal politics. Your investment can suffer significantly if a key team member leaves, or the CEO misuses funds. A competitor could enter the market and take profits, or internal politics could bring product development to a crawl. A good team is critical, and you should know how you should evaluate them.
3. Platform investing risk
While crowdfunding platforms are regulated by the SEC there is still a risk of them shutting down. Ensure that the platform has enough resources. View our analysis of the top crowdfunding platforms. The best platforms may even help the startup grow after it raises money.
4. Industry Risk
Sometimes a startup can fail because of a change that is uncontrollable. If you invest in a brewery and the state it operates in restricts the allowed alcohol content, your investment could suffer. Unlike firm specific risk, industry risk is not dependent on team or their ability to make decisions. Your decision to invest should consider the inherent risk of the industry. Another way to combat this risk is to diversify your portfolio, making sure to invest in companies in different industries.
5. Inflation Risk
The purchasing power of a dollar can decrease over time due to inflation. Sometimes your investment may gain in dollar value, but if it doesn’t keep up with the inflation rate you are ultimately losing value. To avoid this risk make sure the you could make an investment in a startup that pays out yearly dividends.
6. Opportunity Risk
When you make a monetary commitment there is an opportunity cost. You can no longer use those funds to make other investments. Compare all your possibilities beforehand so you don’t regret having your money tied up.
7. Profit and Liquidity Risk
When you invest you can lose money, everything you put in could go to 0. Investing in startups usually takes a long time to pay off, you might not be able to take profits for a few years. If you know you’ll need money in a year, you may need to reconsider. Essentially investments in startups are illiquid, meaning you’ll likely have to wait a considerable amount of time to claim any gains.