Startup Equity Investment: 7 Things to Consider Before Investing
Modern-day investors are willing to explore unique alternative assets that can provide diverse exposure and innovation for their portfolios. They seek to diversify their portfolios and balance their risk and returns. One such avenue for modern investment is startup. Specifically, investing in startups through equity can provide exposure to early-stage businesses and a unique diversification to the portfolio.
Moreover, the Indian startup economy can potentially reach a valuation of US$1 trillion by 20301. It presents a significant opportunity for investors to diversify their portfolio with startup equity investment. This blog explores different opportunities and risks for startup equity.
How Does Startup Equity Investment Works For The Investors?
Finance is the lifeblood of any business, and for startups, securing the right funding is essential for growth. There are various ways to fund a startup, including debt and equity. One of the most effective methods is raising capital by offering startup equity. From an investment perspective, startup equity is a unique financial instrument that grants fractional ownership in a newly established, fast-growing company.
Retail investors can invest in startups through venture capital, crowdfunding and angel investment funds. Moreover, they can invest in Category 1 of Alternative Investment Funds (AIFs) for better diversification. As of September 2024, it accounts for one of the highest shares in the total AIF investments in India.
In the early years, the investors determine the startup valuation and invest through equities in private placement. If the startup grows, investors earn significant returns. However, if it fails, the valuation can significantly decline, and investors may lose their equity value. Therefore, startup investments are a double-edged sword for investors.
Why Invest In Startup Equity?
Startup Equity is a modern investment that can benefit investors and provide earning opportunities in many ways, as follows:
1. Potential For High Benefits
In the early years, the finance requirement of a business is high. Offering ownership share in exchange for finance can be one of the efficient ways for these early-age entities.
Investors can earn significant returns in the long term if the entity consistently performs well in the market. Moreover, due to the early stage, the benefit of a long business life cycle can compound these returns from a startup investment.
For example, in 2016, Mr.Ratan Tata invested US$ 0.2 million in an early stage of an entity named Upstox3. As per the October 2024 report, his investment has compounded 232 times at a compounded annual growth rate of approximately 97%.
However, to earn such significant returns, one of the most crucial startup investment tips is to determine valuation with the nearest accuracy. It can help tap the potential investment and benefit in the long term.
2. Diversification Benefits In An Investment Portfolio
Startup equity offers a unique and modern alternative to traditional equity investments, providing the potential for significant portfolio growth. It helps balance risk and returns by complementing investments in well-established companies. Additionally, investing in emerging startups that address market gaps and cater to evolving consumer needs can offer long-term financial benefits to investors.
3. Opportunity To Support Innovation And Disruptive Businesses
Investors can become a part of modern-day innovation with startup investments. There is an opportunity for investors to support new ideas and technology to tap high-impact and less-penetrated markets in the early years through startup funding. Usually, such opportunities can significantly benefit the institutional investors due to the large requirement of investment corpus and market support.
For example, Zomato has been a pioneer startup in the food delivery business in India4. It has generated significant value for the investors over the years. Overall, as of 2024, the valuation of Zomato has gained nearly 281% since its listing.
Risks Involved In Startup Equity Investment
A crucial chapter of the startup equity guide is its high-risk nature. An early stage of a business is an uncertain period to determine the future trajectory of the business. Therefore, investors should also consider some risks before investing in startups.
1. High Volatility And Business Failure Risk
When a company is newly entering the markets, it may face several hurdles like competition, market positioning, brand establishment, customer response, legal compliance and more. Therefore, the growth is highly volatile in this period. Investors finding startup investments suitable may demand high patience during the early years of the business.
Moreover, there is a risk of multiple factors affecting these entities adversely. Even a negligent loophole can fail the entire business, and the startup valuation can drown. For example, data suggests that in the backdrop of a growing startup economy, nearly 500 of the total registered startups failed in 2024 in India5.
2. Liquidity Challenges
Due to the early phase and impending long business life cycle, startup equity investment may not be easily liquid. Moreover, factors like less number of investors in the market, poor cash flow of the startup, rapid growth and so on can affect the investment.
Some of the most common startup equity tips to handle liquidity of such investment are diversifying the portfolio in diverse assets, valuing the investment holistically before investment, keenly monitoring the investment and withdrawing if there are red flags in the startup.
3. Legal And Regulatory Considerations
Some common risks for a startup can be the dynamic legal framework for a particular industry, extensive compliance requirements, political aspects and policy changes. It can affect the operations and overall market position of a startup, which can end its journey even before the establishment.
Also Read: Market Volatility And Investment
7 Things to Consider Before Investing In Startup Equity
Analysing this mixture of opportunities and risks in startup investments, here is the short startup equity guide that can help investors plan, maintain or continue investments:
1. Holistically Value The Company
Funding a startup with your hard-earned money should follow its holistic valuation of quantitative and qualitative aspects. Determining the financial valuations, total addressable market or market share may not be enough. Investors should also determine its sustainability, management capacity, operational efficiency and more.
2. Understand The Business Model And Sector
It is a common tip for every investment, as business is the core function of an entity. Understanding the business model, the industry, factors affecting them and overall viability can help estimate the long-term value of an investment.
3. Decide The Exit Strategy
Along with investment, investors should also decide the time frame for their investment, expected returns or events that will encourage investment exit. It can potentially safeguard investors from uncertain volatility and high risk.
4. Constant Monitoring Of The Investments
Investors should constantly monitor their startup investment, news about the entity, market updates, and more for timely investment or exit decisions.
5. Analyse The Existing Portfolio
The existing diversification in the portfolio, its industry exposure, asset exposure and investment corpus are some details that investors should consider before investing in a particular startup.
6. Decide The Weightage In Your Portfolio
Startup investments can be a long-term opportunity coupled with high volatility risk. Therefore, based on the risk tolerance and investment objective, this weightage can be balanced in the portfolio.
7. Stay Informed And Seek Expert Advice
Investors should avoid emotional biases like greed, fear, or attachment when making investment decisions. Consulting industry experts, staying updated on market trends, and analyzing financial statements can help maintain a rational and well-informed approach to investing
Conclusion
Startup equity is the investment tool that provides fractional ownership of a newly established entity. These are double-edged swords for investors that can generate potential returns in the long term but can also pose significant volatility risk. Therefore, by balancing these opportunities and risks, investors can explore startup equity investment based on their risk appetite and investment aspirations.
Planning to invest in innovative assets like startup equity? Log in to Grip Invest and explore unique investment opportunities like Securitised Debt Instruments (SDIs) today!
Frequently Asked Questions On Startup Equity Investment
1. Do AIFs offer startup equity investment opportunities?
Yes, investors can invest in startups through angel funds or venture capital funds. Category I of Alternative Investment Funds can help process these investments. Along with startup investments, AIFs can also help diversify the portfolio into other alternative assets. Overall, AIFs can be a potential medium for startup equity investments.
2. What is seed funding?
Investing or funding a startup in its initial ideation stage is known as seed funding. It is the most crucial stage for a startup to get this funding to start the operations, execute the idea or expand the existing setup. Seed funding can be highly risky for investors, as determining the valuation or actual potential of a startup can be difficult.
3. What is a bootstrap startup?
It is a stage for the startup where the whole entity is set up without any external funding or investment. In bootstrap startups, the founders invest capital in their ideas and build the entity without dissolving any equity share. It can be a slow process but significant in terms of control and innovation of the founders.
References
1. Business Standard, accessed from: https://www.business-standard.com/companies/start-ups/startup-contribution-to-economy-projected-to-reach-1-trillion-by-2030-124121000842_1.html
2. Securities Exchange Board Of India, accessed from: https://www.sebi.gov.in/statistics/1392982252002.html
3. Business Today, accessed from: https://www.sebi.gov.in/statistics/1392982252002.html
4. Business Standard, accessed from: https://www.business-standard.com/companies/news/35-million-to-29-billion-how-deepinder-goyal-built-the-zomato-empire-124100700258_1.html
5. Financial Express, accessed from: https://www.financialexpress.com/business/sme-5000-startups-registered-under-startup-india-closed-so-far-govt-data-3688692/
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