To sharpen investors’ assessment before investing in startups, they can ask prospective startups five principal queries, including the required level of involvement and timeframe.
Heaptalk, Jakarta — Investors have various ways for devoting their money, including funding a startup. Investing money in startups indeed has the potential to provide significant returns. However, this business is not risk-free as there is no guarantee that the startups will run and grow well for later generating returns. Otherwise, if it fails, investors may not gain anything.
To sharpen investors’ assessment before investing in startups, they can ask prospective startups five principal queries, as cited from Investopedia. These queries include the required level of involvement, timeframe, expected rate of return, diversification of investment portfolio, and exit strategy.
-
What level of involvement is required?
The level of involvement when investing in startups is commonly associated with the type of investment. For instance, someone who invests in a startup through a venture capital firm would have limited interaction with the team running the startup.
Meanwhile, an angel investor will be given an equity stake in the company which means they have the opportunity to participate in decision-making with the startup’s leadership. In comparison, an investor who funds a startup’s crowdfunding campaign will also receive a share of equity but they will not have the same scope of control as an angel investor. Therefore, investors should convey the desired level of involvement clearly when handing over money to startups.
-
What is the timeframe?
Investing is a long-term business that takes years to generate profits. However, investors should know the timeline to compare it with personal expectations. According to Investopedia, there are some investors who are comfortable with waiting ten years for gaining returns, while others want to obtain their money back within five years.
Evaluating a startup’s track record can help investors estimate the investment period, one of which is by looking at the burn rate which reflects how much money is spent each month. If a startup is still in its early stages but the burn rate is very high, it may be a sign that investors will be waiting longer to receive payments.
-
What is the expected rate of return?
Before deciding to invest, investors must analyze the potential return on investment (ROI) in an effort to maximize income, although the amount of return also depends on the type of investment made. For example, angel investors typically expect annual returns in the 30-40% range.
On the other hand, venture capitalists assume a higher level of risk which means a higher expected rate of return. Meanwhile, equity crowdfunding is an equally high-risk investment strategy. The average rate of return through equity crowdfunding is quite difficult as this strategy is still relatively new.
Investors should include any cost components related to the investment, for example, the annual management fee from venture capital or the cost of using a crowdfunding platform service. The amount of this fee certainly affects the amount of return that is obtained by investors.
-
How does the investment affect diversification?
Diversification can be used as a benchmark for a solid investment portfolio, aiming to minimize risks without limiting returns. Before deciding to invest, investors should consider about how the investment affects their overall asset mix and level of risk.
In general, the more startups invested by investors, the greater the chance to achieve the target return. At the same time, spreading funding too small can backfire if there are no winners in it.
-
Is there a clear exit strategy?
Having a clear exit strategy is a must-have requirement in any investment. Investors must understand when and how they can withdraw their initial investment, including the returns. For example, angel investors need to know at what point they can sell their equity shares. This question is closely related to the previous question namely knowing the time frame involved to ensure investors can exit at the right point.
