The initial investments may be high but the windfall gains on the success of a company would also be humongous
They say to get rich you have to make money while you’re asleep, which certainly requires a new approach to investments and out-of-the-box thinking. According to the risk-return trade-off, the higher the risk an investor takes, the potential returns are also higher. Therefore, although fixed income investments are safer, the returns are limited. For risk tolerant investors, investing in some of the upcoming start-ups can be one of the options. According to the Government, India is the second-largest start up ecosystem in the world growing at the rate of 10-12 per cent year-on-year. The number of innovative new firms in India has grown to 50,000 from 7,000 in a decade, according to a KPMG report released in February.
What is a start-up anyway? Any business that can bring about a disruption in the existing industry and give convenience like never before through an app or usage of technology can be defined as a start-up. Order groceries, without leaving your house, by using BigBasket or Grofers. Need cab at midnight? Call Ola or Uber. These are some of the examples of noteworthy start-ups. Most entrepreneurs begin small while developing their initial idea and then as they build their businesses, go for additional funding from angel investors or venture capitalists. And if they are successful, along with them, all the lucky investors who believed either in the product, service or the entrepreneur and took a risk by investing in the fledgling company, are able to cash in big.
So, how can we, as investors, be a part of this growth story and hope to make big gains? We can do that by investing and buying a piece of the firm in exchange of equity, which essentially means buying a portion of the ownership which gives us the right to future potential profits. However, a word of caution here — if the company fails, you lose your investment. Suppose for a growing company all the profits are reinvested, then how do you make profits? If we believe that the start-up we chose grew quickly, then we as investors make a profit from their investments when we sell part or all of our portion of ownership in the company during a liquidity event, such as an Initial Public Offering (IPO) or acquisition. During a successful IPO, there is a considerable rise in the share price as compared to the initial investment, increasing the value of investors’ holdings and giving shareholders the opportunity to trade their stock on the public market if they want to liquidate or cash in their shares. That was the good news! Now the bad news is that 90 per cent of the start-ups fail. It is also difficult to sell off their equity before its IPO. However, having said that, this increased risk is coupled with the potential for a very large return if the company succeeds and can be a good investment option for risk- tolerant investors
Having understood the pitfalls and the risks involved in investing in start-ups, there may be some investors who would want to bet on the future of some such firm. Such investors can start by joining an angel network preferably with the nation-wide coverage to be able to give access to start-ups throughout India. With this larger opportunity set, one should focus on the promoters, their vision and mission and their capabilities to take the venture forward. The advantage of these networks is that the preliminary due diligence like discovery of the company, initial project evaluation, documentation and constant monitoring post -investment is being handled by them and the investor has to simply take the decision to invest by taking advantage of their expertise. Often, it can get very overwhelming sometimes, particularly if you are starting new. So, an investor should observe what experienced angel investors are doing, build his own understanding of the start-up ecosystem, find out the sunshine sector and then invest. Some of the websites that an investor can visit are LetsVenture, AngelList or OurCrowd. Retail participation in start-ups is facilitated through an angel fund, which is a Special Purpose Vehicle (SPV) fund, registered under the SEBI. Indian investors can also participate in syndicates, which are private investment vehicles led by experienced technology investors and financed by institutional investors and sophisticated angels, created to make a single investment. The advantage of syndicates is that the investors can participate with lower minimums and can get access to some of the top deals, which are typically hard to procure for someone who is not experienced in building deal flows. Personalised deals are available for investors with higher fund availability, where he can personally scrutinize different ventures and invest in them after due diligence for price discovery and some smart negotiations. The initial investments may be high but the windfall gains on the success of the company would also be humongous.
Although risky, start-up investing is an alternate investment avenue for investors who are willing to be a part of the vibrant community by investing in them for potentially higher gains. So, get on the start-up bus and add a new leaf to your investment portfolio.
(The writer is Assistant Professor, Amity University)
Wednesday, 25 September 2019 | Hima Bindu Kota
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