According to Harmel Rayat, there are many reasons to consider investing in a start-up. In fact, the benefits can be not only financial, but also deeply personal. By investing in a start-up company, you are effectively investing in creativity, innovation, and entrepreneurship. You are playing a direct role in the cultivation of a new business and of new jobs—all of which can be immensely satisfying.
There are dangers, too. For one thing, it is difficult to pick a winner; there are countless new companies emerging every year, and investors know full well that only a fraction of them are sustainable. This financial risk carries with it much potential for financial reward, however; according to a recent Forbes article on start-up investment, returns could yield anywhere from five to 100 times the initial investment.
While it may be impossible to pick a winner with any certainty, there are certainly some steps that investors can follow to ensure that they are minimizing their own risk, while maximizing their odds of latching onto something sustainable. Harmel Rayat shares a few of his favorite start-up investment tips in the paragraphs that follow.
– For one, he says, it is important to invest in a domain that you know and understand.
“Knowledge helps to mitigate risk,” Harmel Rayat affirms. “One of the best ways to reduce risk is to really understand the market that your start-up operates in. If you understand the market, you understand the metrics for success and the real potential that the venture has.”
Investing in a known industry also makes it possible to invest in a business with a truly scalable model.
– Harmel Rayat also notes that, while the business model itself is important, so is the track record of the founders.
The Forbes article makes much the same point: “The people behind the company are the most critical factor, especially for early stage companies. This is mainly due to the fact that products need to be iterated several times until they are able to find where they fit in the market.” As such, investors are encouraged to check out the founders’ background stories, their educational histories, previous companies worked for, and so on.
– As in any field of investment, diversification is also key. Instead of placing all of an investment into one company, it is smart to make multiple, smaller investments. This increases the possibility of success and reduces the risk involved.
Moreover, Rayat says this increases the chances of getting your money back at a liquidity event, like a public offering.
– “It pays to examine the company’s monetization strategy,” continues Harmel Rayat. He explains that the first dollar is the one that matters the most.
An investor needs to see how the business is going to be able to scale up down the line—so the company needs to charge a reasonable price for its services. “You obviously do not want to invest in a company that is not sustainable, so a clear path to monetization matters a great deal,” he says.
– While it is crucial to explore the business plan and the background of the start-up itself, some investors fail to explore the market more broadly—in particular looking at the start-up’s competition.
Here again, the Forbes article is clear: “It is absolutely critical to see what competition the start-up has and what kind of competitive advantage they have been able to put in place in order to beat everyone else in the race. The competition could acquire the start-up instead of cloning their work, so investigating the appetite in the market could be beneficial.”
Furthermore, investors want to back a start-up that is operating in a fairly large field, so some market research is critical.
– Harmel Rayat encourages investors to check out the start-up’s financials. “The company will not be able to predict its five-year or 10-year financial forecast with any certainty, but it should be able to furnish investors with a road map of where the founders want the company to go,” he says.
“Incidentally, you also want to make sure the company has a plan for where your money is going. Don’t give a dollar without seeing how that dollar is going to be spent.”
– Finally, Rayat says investors will want to be familiar with how a company is structured if they are going to be stakeholders within it.
A good way to achieve this familiarity is to review the company’s legal documents. Articles of incorporation or company by-laws should provide some insights into how the company is actually run, how decisions are made, and who the true owners really are.
Harmel Rayat concludes by noting that investing in start-ups is anything but a sure thing—yet a little bit of strategy can make the process more likely to succeed.