As we noted in earlier posts, the risk profile of investing in startup companies has shifted, making startup investing a more attractive alternative investment than it might have been in years past. In saying that, investing in startup companies is still very risky. In this post, we will discuss a few of these risks, and in subsequent posts, we will present several strategies that will help mitigate these risks and increase your chances of being successful.
The first risk inherent in Angel investing is small business risk. Small businesses face several hurdles that larger businesses do not necessarily face. For example, they are at a higher risk of running out of capital, as small businesses may not have as many loyal or recurring customers as an established company and may not have anticipated unexpected roadblocks. If they are pure startups, they may not have many customers at all, and, therefore, they may have to spend exorbitant amounts of money to attract customers. There are many other reasons that make small businesses risky investments – Is the idea good enough, or is it untested? Do they have enough money to support fast growth? Etc. We call this risk, “small business risk,” and we will talk about strategies to mitigate this risk in an upcoming post.
The second risk is called “liquidity risk.” Angel investments are different from stock market investments in that you cannot sell your investments whenever you would like. When you invest in a startup company, you have to wait for an “exit event,” or a “liquidity event,” which is when the business sells itself or when a third party comes in and buys all or part of the shares of the company that you own. Exit events do not typically happen quickly; in most cases it will take several years. For that reason, when you consider Angel investments, note that your money may be tied up for a long period of time. We will touch on a few strategies that will help mitigate this risk in an upcoming post.
There are many other risks associated with investing in startups, but most can be generally categorized into these two risks. Our next post will address methods of reducing these risks before you make an investment decision.