Thinking about investing in a startup? Doing so can give you the opportunity to obtain great benefits, but only if you are willing to assume a high risk. For that reason, when making an investment in startups you must be well prepared, having carried out a thorough prior study if you want to get a good return. Take note of the steps to follow.
Why invest in startups?
Usually, at the beginning of their activity, startups require external financing mechanisms to develop, which can be public or private financing. In this second case is where you could participate if you consider investing in a startup.
These innovative companies have a lot of potential and, therefore, many possibilities to grow and bring you profitability. In addition to this, if you are wondering why invest in startups, other questions you can consider are:
- You will be part of innovative projects, some very capable of solving relevant problems.
- You will be in contact with the entrepreneurial ecosystem.
- You will be able to obtain tax benefits. As detailed by the Tax Agency, in Spain it is possible to deduct 30% of the amounts spent during the year for subscribing startup shares or participations.
How to invest in startups: fundamental tips to achieve profitability
Before investing in startups, it is essential to understand the environment in which they operate, since, as we have mentioned, this type of bet can offer a high potential reward, but it also involves a very high risk due to the lack of references and the uncertainties of the market.
Once you have studied this well, follow the next steps:
1. Define the investment strategy
To define a clear investment strategy, it is essential to answer a series of questions, such as:
- In which sectors or industries do you have the most confidence or knowledge?
- How much capital are you willing to invest?
- What is your risk tolerance?
- Are you looking for short-term or long-term returns?
The answers you get will help you establish a framework for your startup investment decisions.
2. Research
Thorough research is key to minimize risk. To do so, you should consider the following steps:
- Market analysis. Make sure the startup operates in a large and growing market. In addition, research its current and potential competitors, and evaluate the startup’s position in its context. On the other hand, examine its track record (e.g., have they won any awards, participated in accelerators, etc.) and the capabilities and skills of the founding team. Make sure they are fully committed and have a clear and compelling vision.
- Study the product or service. When investing in a startup it is best to opt for an innovative product or service, differentiated from the competition. In addition, market validation, i.e., acceptance tests, such as early customers, is crucial.
- Financial analysis. Understand how the startup plans to make money, evaluating the viability and scalability of the business model. Also, review the financial projections and make sure they are realistic and based on sound assumptions. Finally, you need to understand how the funds you invest will be used. Plans for use must be specific and strategic.
In this last aspect, that of financial analysis, if you detect that the startup in which you want to invest has opted for an external CFO, it is a sign that it knows the importance of good financial management and prefers to leave it in professional hands. Take it as a big plus.
3. Diversify
In order to know how to invest in startups and obtain profitability, it is important to consider diversification. Diversifying your investments is a strategy to mitigate risks.
This means that you should not allocate all your funds to a single startup, but rather invest in several startups. This increases the chances that one of them will be successful and compensate for the possible losses of others.
4. Know the different ways to invest in startups.
In the past, investing in startups was only a matter of having contacts and/or money. However, nowadays, investing in startups has been democratized and there are several tools to finance startups directly and indirectly. For example, to invest in Spanish startups, you can opt for one of these methods:
- Business angels or angel investors.
- Venture capital or venture capital funds.
- Equity crowdfunding platforms. Some of the best platforms to invest in Spanish startups are Dozen Investments, Crowcube, Startupxplore or SEGO Venture.
- Incubators and accelerators.
5. Provide value beyond capital
If you want your startup investment to be successful, consider how you can provide additional value beyond money. For example, you could offer strategic advisory mentoring based on your experience.
6. Determine an exit strategy
To obtain profitability in startup investing, it is crucial to have a clear exit strategy. Common ways to exit a startup investment are:
- Acquisition: the startup is bought by another company.
- Initial public offering (IPO): the startup becomes a public company.
- Secondary sale: you sell your shares to other investors.
Each of these exit strategies has its own tax and liquidity implications. For that reason, planning ahead will help you maximize returns.
7. Continuous follow-up and support
Once the investment has been made, don’t relax. Even if you only contribute money, it is important to maintain regular communication with the startup to keep abreast of its progress and the challenges it faces. Ask to participate in board meetings and stay informed about achievements and financial results.
8. Legal and tax considerations
Of course, you should make sure you are well informed about the legal and tax considerations of investing in a startup, consulting with lawyers and tax advisors to understand the requirements and implications.
At The Startup CFO we take care of the financial management of startups so that they can fully focus on their project. To this end, in addition to being their external CFO, we help startups find the best public financing options, and we offer consulting, management and specialized legal services.
All this, with the purpose that the projects can reach success and that those who invest in them, such as you, achieve maximum profitability.
