Are you thinking about investing in a startup but wonder about the pros and cons of this investment? Is investing in startups a good idea or not?
There is really no easy answer to this question because there are many factors to consider as each startup is different. The biggest thing to remember overall is that investing in startups is a high risk / high reward investment.
The investment you are making comes with a high risk as there is no guarantee of success, most new businesses fail by year 5 if they make it anywhere near that long. However, if you do invest and the business does succeed there is a great possibility for a very high financial reward.
If you are willing to make the initial investment and you do end up succeeding, it could be one of the best investments you have ever made. Because of the high risk / high reward model, most investors who invest in startups invest in many.
They understand that the money they make will likely only come from one or two of their investments, so it is just not feasible to only invest in a few startups.
The Pros and Cons of Investing in a Startup
Now that you understand that there is a certain amount of risk involved when investing in startups it is time to delve a little deeper. You will need to understand the pros and cons of investing in a startup if you are trying to answer the question is investing in startups a good idea.
Also check out, How much do startups spend on marketing?
Looking at the Pro of Investing in a Startup
- Ground Level Opportunities – For some investors, part of the excitement and allure comes into getting into a company at the ground level. This can be for potential profit down the road or even just having the ability to be a part of a success story from as close to day one as possible.
- Small Investments – If you are looking to invest but either do not have a large amount of money to invest upfront or you want to split your investment capital between multiple companies, startups can easily allow you to do this. Most startups do not need a lot of money so you can get a bigger portion of the company with a smaller investment. This will also allow you to invest in multiple;e startups at once allowing you to have a more diversified portfolio as well as a higher chance that one of these companies will become successful.
- More Investment Options – When you are investing in a startup instead of an already established business you may have more investment articles open to you. For instance, most businesses only allow you to invest by purchasing shares. Many startups also allow you to buy convertible notes. Convertible notes can be changed to shares and equity in the company later.
- Working With Highly Motivated People – When you invest in a company from the beginning, the possibility that the owners and managers are more motivated towards success or making a real difference is much higher. People who are creating something new have a much more optimistic viewpoint and tend to work harder towards their goals.
- Widely Available Investment Opportunities – There are over 1 million companies in the startup phase yearly in America. Although many startups do fail, almost half of them report money issues as the primary reason. With these types of numbers, you can see that there is an abundance of investment opportunities available. A large amount of startups that someone can invest in allows these investors to easily find startups in the category or niche they are looking for. It also allows investors to take the time to look for startups that really speak to them, as chances are they will find multiple companies that fit their needs.
- Larger Possibility of Growth and Profits – Investors know that they can make money by putting their money in well-established companies. The problem is that because they are well-established, the potential for a huge amount of growth or huge amounts of profits is just not there. When you invest in a startup, sure it is a high-risk investment. However, most high-risk investments come with high rewards if the investment hits. Every large company that makes millions to billions a year was once a small startup. There is not a huge likelihood that you will invest in one of the powerhouses of the future, but there is always a chance that this can happen. That very slim possibility is part of what keeps investors coming back to startups every year.
- Changing The World (or at least a small part of it) – There are many benefits of investing in a startup that is related to growth potential or making your money back manyfold. However, some investors are not just led by their wallet, but by things like their heart, values, vision for the future, or their conscience.
In what way an investor wants to change the world is an individualized goal or vision, but with so many different options available they can seek out companies that not only seem like they have a profitable idea and a solid business plan but ones that share some kind of vision of a future world the investor wishes to see.
The list of types of businesses could be endless here but these could include clean energy, robotics, AI, crowdfunding, cheaper education for all, vegan or vegetarian alternatives, and more.
Looking at the Cons of Investing in a Startup
- Higher Probability of Losing Initial Investment
When you are putting your money in an unknown business idea or an unknown company you have a much higher chance of losing your investment than you would if you were investing in a more established business model or popular and already profitable company.
When someone is asking if investing in startups a good idea the chance of losing their investment will probably be the biggest downfall and con on their pros and cons list.
When people are looking at high-risk, high reward investments, much only focuses on the potential of the high reward.
However, a more cautious person is going to weigh whether or not they can afford to lose the money they are investing. If you need to see a profit or even a quick turnaround on the investment, startups are not the right choice for you.
However, if the money you are investing is extra money you do not need and can afford to lose, startups are a good investment and a great way to diversify your portfolio.
- Even When the Investment Pays Off, It Takes a Long Time
Although the potential growth and profit for a startup can be astronomical – it is something you will need to commit to for the long haul. These risky investments will take patience on your part even when startups become successful. It is usually many years after your initial investment.
- Saturated Markets
Although you have a large pick of different startups to invest in, many are in similar markets and these markets are already saturated with businesses trying to find success.
You will need to find a startup that really has something special to offer. They need to stand out from the rest of the crowd or it will be an uphill battle to succeed.
This is certainly something to keep in mind when looking for the perfect investment. You should ask yourself a series of questions about what makes this company special and why does it have a better chance of success than other companies.
- Great Idea Versus Not So Great Owner / Management Team
Sometimes someone comes up with an idea that is so incredible you really think it will work and you are so excited by the innovation or the idea of how this one idea could change the business world you just want to leap right in.
If you are in this situation I advise you to take a step back and then look a little more carefully. One fantastic idea does not make a successful company. You need a great idea, sure, but you also need a great owner group, fabulous management, and a stellar business plan.
Many people can come up with incredible ideas, but those same people are not always the best business owners.
Take the time to understand the business plan, the overall business model, and the people who own the business as well as who will be running it. This is a situation where you need to look at the full picture.
- Some Failures Can Not Be Predicted
The final con we should highlight for startups is that not all failures can be predicted. Sometimes the idea and the people are great, you are assisting with funding and the business plan looks sound, but for one reason or another it just does not work out. It happens.
Failure happens in life for all people. In fact, most people who are successful had many failures before finding success.
Understand that even if everything looks great, the business can still fail. Most successful business owners will tell you that they believe luck plays a role in their success.
This is not to say that they did not come up with a great idea or that they did not work hard – but lots of people are smart and hard workers and they still fail.
Everything needs to go right to find a certain level of success. This can not happen all the time, for every business, or for every investment.
Why Do Investors Invest in Startups
A good portion of the reasons why investors decide to invest in startups can be found in the pros section of the pros and cons list above.
However, sometimes there are reasons they invest that have nothing to do with the financial aspect (or at least very little). Here are some reasons for the question of why do investors invest in startups.
- The Owner or Management Team – Listed under cons we have the owner and management staff, but sometimes it is the opposite and the very reason someone invests. The idea may be average at best, but if you have an owner or management team that is skilled in professions, has an incredible business plan, or already has the right contacts – you might invest because they are running this business.
- Personal Connections – A lot of people get their initial investments due to personal connections. The first investors are often friends, families, and colleagues.
- Diversifying Your Portfolio – Another popular reason to invest is to diversify your portfolio. If you already have investments in large and medium-sized successful companies you might want to add some startups to your list of investments. You also might be looking to invest in different areas. For instance, if you have a lot of investments in oil, gas, and coal you might foresee that these were the ways of the past, and going forward at some point people are going to switch over to greener energies. You might want to get in on the ground floor of some of these energy companies to have all your bases covered that regardless of what kind of energy is being utilized, you could be making money.
- The belief of a New Idea – Sometimes investors choose to invest in a startup because they believe in the idea this startup is based upon. It could be something brand new that they have never run across in a business before or quite possibly just something they could not afford to financially back before this point in their life. Sometimes investors are just following their passions, values, or even where they stand politically.
- Making a Difference – An investor might see a way to make a difference through their investment. This could be just helping someone start a business and turn their life around or because they believe the product or service offered could help change many lives for the better.
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Bijay is an entrepreneur and start-up founder having more than 14 years of IT industry experience. He is the co-founder of TSInfo Technologies, a SharePoint development company.
A dedicated professional and very passionate about public speaking and also wrote thousands of technical blogs in various technologies. He also wrote a lots of blogs on entrepreneurship, investment, startup, business, manage money tips, etc.