In the booming age of startups becoming unicorns and not remaining so, it is crucial to evaluate your investments correctly. India is claiming exception to the impending recession with the reduced Wholesale Price Index (“WPI”).
This could mean that the market conditions for startups in India may not be as challenging as, North America.
Although, there are factors that may lead to a decline in your investment value. This blog, has the support initiatives from GoI but are these sufficient to beat the uncertainties?
In G.S.R. notification 127 (E), GoI has notified entities which can be regarded as a startup. The eligibility criteria include –
- Has not yet completed tenure of ten years from the date of incorporation
- Is a private company or registered as partnership firm or a limited liability partnership
- Has an annual turnover not exceeding INR 100 Cr for any of the financial year since incorporation
- working towards innovation or improvement of products or services or is a scalable business with a high potential of wealth creation and employment generation
- Is not an outcome of reconstructing or splitting up a business that was already in existence
If you are evaluating the investment options, one rule ingrained in the investor’s mind is “Higher the risks, better the rewards.” But is that really true with startup investments?
With this, the top 5 risks identified for startup investment are hereunder –
- Illiquid investment – startup investments have proven to be best with the long-term approach since market maturity has a role to play. The investment, therefore, is illiquid compared to equity investment in companies or cash. The risk of forfeiting entire investment due to product and market imperfections, remain.
- Delayed exits – Each co-founder agreement details the lock-in period, possibly the Right of First Refusal clause (“FoFR”) and a non-compete tenure. The Exit gestation are long and can be considered delayed. Read more on the different clauses of the Co-founders Agreement here.
- Unevenly distributed returns – The returns can be uneven and delayed with wating out the market dynamics. Returns have to be distributed among co-founders and investors based on their stake in the business, which results in unequal profit split.
- Product market performance – When introducing a new product/service, the startup’s biggest fear is product acceptance. A failed market launch can be an impediment for the startup to overcome.
- Lack of mentorship – As a budding entrepreneur, the dingle biggest challenge is around finding the mentor who can handhold for the initial phase and guide through. Shark Tank (which had done a India version), is popular show which is like a short cut to having a long term mentor.
And as bad as it may sound, some founders do face what is popularly coined as “Founder’s syndrome,” which hampers growth as the founder struggles or refuses to change gear and adopt a new mindset, approach, or skill set for the organizational growth and as the strategic context changes.
So, why invest in a startup?
- Long-term growth – If the risks are hedged and some patience is cultivated to wait it out, incremental goodwill and monetary profits on the investment value can accrue. But this is only possible in the long term and not short term.
- Range of options – with innovation and disruption the competition and the options to invest are high. This can make for multiple investment options.
- Diversification – it can be a way to be part of a statrtup and new idea without being a co-founder. As an active equity investor, debt lender, or passive investor, you can diversify your investment bucket and make the highest yield.
- High potential for a buyout – a mature and stable product and yield to a higher return and a potential for buyout – not just by the new investors but also by existing investors/co-founders. RoFR can prevent the dilution and offer a chance to build on their stake.
- Impact investment –With growing environmental consciousness, investments are now made to generate positive, measurable social and environmental impact alongside a financial return. Startups need to highlight the solution their product/service is offering to make a point.
- Giving back to the Community – it is a good opportunity, as an investor to invest in a venture you believe in and offer it the experience and value you can offer and see it benefit larger segments of society.
With the mandatory risk disclaimer being given at the time of inviting investments, it is crucial to consider and evaluate the following while deciding on the opportunity –
- Is the market ready or is seeking the product/service?
- Is the company scalable?
- What are the entry barriers including well-established competitors and their goodwill?
- What is the company’s project financial growth over the next 5 years?
- Are the management and team qualified to run the business effectively?
- Does the investment fit personal preference?
Answering the above questions positively will help mitigate some eminent risks but it may not fully cover for all.
This is only for informational purposes. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein. Endeavoured to accurately reflect the subject matter of this alert, without any representation or warranty, express or implied, in any manner whatsoever in connection with the contents of this. This isn’t an attempt to solicit business in any manner.