Investment in equity securities of startups is accompanied by certain risk factors. Therefore, prior to investing in a startup, you need to be aware of and evaluate certain considerations:
- Loss of Capital: Investments in startups involve a high degree of risk. There is no guarantee that most startups will succeed. Therefore, it is imperative to consider your risk appetite as it is more likely that you may lose all of your invested capital than see a return on capital or a profit. Hence, you should invest such money that you can afford to lose without altering your standard of living.
- Rarity of Dividend: startups may not have the capital/ tolerance to pay dividends. This means that if you invest in a business, even if it is successful, you are unlikely to see any return on capital or profit until you are able to sell your shares in the invested company. Even for a successful business, dividend pay-outs may be unlikely for a number of years from the time you make your investment.
- Changing Economic Conditions: The success of any investment activity is determined to a certain extent on general economic conditions like, the availability of external credit markets, equity markets, stability in global economies, etc. There can be no assurance that such markets and economic systems will be available as anticipated for an investment in a startup to be successful.
- Future and Past Performance: The past performance of a startup cannot be indicative of a startup’s future results. There can be no assurance that targeted results will be achieved. Each startup’s future statements are based on management’s current expectations and assumptions regarding the startup’s business and performance, the economy, etc. As with any projection or forecast, forward-looking statements are inherently susceptible to uncertainty and changes in circumstances.
- Difficulty in Valuing startup Investments: It is difficult to determine objective values for any startup. In addition to the difficulty of determining the magnitude of the risks applicable to a given startup, there generally will be no readily available market for a startup’s equity securities, and hence, an investor’s investments may be difficult to value.
- Lack of Information for Monitoring and Valuing startups: The investor may not be able to obtain all information it would want regarding a particular startup, on a timely basis or at all. As a result of these difficulties, as well as other uncertainties, an investor may not have accurate/ complete information about a startup’s current value.
- Absence of Liquidity: An investor’s investments will generally be private, illiquid holdings. As such, there may be no readily available liquidity mechanism available for any of the investments. This means that you are likely to see a return only upon the occurrence of a liquidity event or an exit. Therefore, understanding the exit strategy of a startup is important.
- Tax Risks: There are many tax risks relating to investments in startups and they may be complicated. You should consult your tax adviser for information about the tax consequences while investing in a startup.
- Regulatory Risks: The investment may be subject to the certain applicable laws of the investor’s country of residence as well as the country where the relevant start up is registered. The investors are advised to seek adequate legal advice in this relation, prior to making the investment.