There is no precise definition of what a startup is. Usually this is a company looking to make an innovative product or extend a service in order to reduce the status quo and thus solve a major problem in the process. For example, Uber created an app to connect passengers and taxi drivers, a concept that changed the way we hail a cab every day. This effectively solved the two-stakeholder problem in an innovative way.
What differentiates a normal or traditional business from a startup, however, is not the actual product or service (although it may be), but the way they both operate. A traditional business grows at a very linear pace through organic growth tactics and is generally profitable from day one. However, a startup grows at a very rapid rate with the help of huge amounts of capital and resources and therefore may not even be profitable for a few years. The goals of the two types of business are very divergent and this is essentially what differentiates a startup from all the other types of businesses that exist.
For example, Facebook has grown into one of the largest companies in the world in the space of a decade, but some companies have been around for two to three decades and have not reached Facebook’s scale until now.
Obviously not all startups get huge and it mainly depends on the idea that is implemented, but the same idea can be implemented with a traditional business mindset or a startup mindset.
Why do startups need money?
As explained in the previous section, startups are businesses that operate with a hyper-growth mindset. They obviously need huge amounts of capital and resources to achieve the same goal which in most cases has to come from external sources. External sources mean that the capital used in running a business is not only the personal capital of the founders or directors of the business, but also of people and businesses outside the business.
These people and companies believe in the business and thus donate money and other ancillary resources to help the founders make the startup successful. In return, they receive ownership of the business (shares) and / or interest on the amount granted (in case of loans). These serve as incentives for people to invest in the business.
Lifecycle of startup funding
A startup raises multiple rounds of capital from different sources and for different purposes during its lifetime. Basically, the types of capital can be divided into equity and debt capital.
A startup ideally repays all of its capital investors when it is bought out by another company or when it makes an initial public offering (IPO) on the stock market. Events like these are called “outings” in the startup ecosystem.
In contrast, an investment in debt has its own repayment schedule and is generally not dependent on the occurrence of an “exit”.
How can retail investors participate in startups?
A retail investor can participate in all of these different investment options throughout the lifecycle of a startup. Investments can be divided into two categories:
- Direct investment – In this case, the investor invests directly in the startup in question without any involvement of third parties such as a venture capital / debt / private equity company. Angel investing is generally a direct form of investing.
- Indirect investment – In this case, the investor invests in a venture capital / debt / private equity firm and then the private equity firms in turn invest in different startups using the money they have raised from investors like you.
The steps to follow include:
a. You must contact your investment / financial adviser in order to invest via the indirect option. He / she will research and give you a list and profiles of all the different funds looking to raise funds at that time.
b. Review the different options available and make a decision on factors such as:
- Asset class type
- Target returns
- Focus of the fund (specific sector, theme, market, etc.)
- Holding period
- Fund manager references
- Historical performance
vs. You can now set up a call with the fund representative to answer all your questions and also pass them on. Usually there will be some paperwork before you can actually donate your money to the fund.
Things to keep in mind before investing in a startup
There are a hundred things to keep in mind before investing in a startup, but here are the top ones that should be on your checklist, no matter what:
- Idea – Usually a start-up investment is just an idea with a small test sample for validation. It is therefore very important to understand the idea and the company before investing in it.
- Founders – As a start-up investor, with very little validation to bet on, the most important people become the founder. The founders run the business, and in a way, as a start-up investor, you invest in the idea and in the people who will implement it.
- Market size – For a startup to give you a good return on investment, it must address a market large enough that it has good potential to become big in the future. A business that only caters to a particular locality or small area can ideally never qualify as a startup, as startups operate on a large scale in their quest to achieve dominant status.
- Competitors – Startups aim above all to scale up at an exponential rate and become the dominant player in the market. Therefore, it becomes very important to know what other players already exist in the market so that the company that you could potentially invest in has good strategies to deal with them.
How much can you invest in a startup?
Anyone, whether Indian, foreign or NRI, is allowed to invest in a venture capital / debt / private equity fund provided you have the minimum amount of funds available to invest in these instruments.
The minimum amount is INR 1 crore for a person investing in any of the above instruments.
An angel investment, on the other hand, has no minimum investment and is therefore purely based on your direct agreement with the startup you wish to invest in.
Should you invest in a startup?
- High reward potential – Typically, a start-up investment is made when the business is small and has a lot of growth potential to become the next big thing. Therefore, if you catch the right bird early on, your investment could grow exponentially within a few years.
- Creator of change – As a start-up investor, you end up investing in ideas and businesses that could change the world for the good. So this is a good opportunity for people to make their contribution to a better world.
- lateral restlessness – Many people who do angel investing actually see investing in startups as a side business from which they can generate an additional stream of income. With the enthusiasm and innovation constantly happening in the startup ecosystem, this becomes a great way to spend your extra hours analyzing and investing in startups.
- High risk investment – As the start-up investments are made at an extremely early stage, the business model and the team may not always be stable like a mature business. Hence, the risk of losing your money becomes high in case the startup eventually disappears.
- High volatility – A startup goes through a roller coaster for the first two years, not only in terms of money, but also of its founders, teams, other investors, market conditions, competitors, etc. Therefore, there is a very high level of uncertainty and risk. both financially and emotionally when you make your investment.
- Long holding periods – A start-up investment generally has an average holding period of 7 to 8 years. It is therefore an extremely illiquid investment which may not be a good idea if you are someone who can use short term funds in an emergency.
The startup ecosystem in India is currently in an exciting phase with transactions and activities taking place at an unprecedented rate. This provides a great opportunity for many retail investors to invest and reap the benefits of the great history of Indian startups. However, it is important that you exercise caution like any other investment and understand your investment well before you implement it.