Imran's personal blog

March 23, 2012

Risks of investing in early stage startups

Filed under: Uncategorized — ipeerbhai @ 6:26 pm

Investing is always risky business.  Its entirely possible for an investor to lose money investing in early stage startups.  Here’s a quick overview of the risks:

  1. Some studies show that up to 90% of new ventures will fail.
  2. Investors are treated as, “Last in Line” in bankruptcy court, and holders of secured notes or other debt instruments will be given any liquidation funds gathered during the businesses shutdown ahead of any investor.  Investors will only be refunded partially if all other creditors are fully satisfied. In practice, a failed startup will not have enough in assets to satisfy all other creditors, so investors are very unlikely to recover any funds.
  3. A failed startup can result in the loss of all assets ventured by the startup, and creditors of any sort are not likely to recover much of their investment should a startup fail.
  4. Investors receive money as distributions from the business, often in the form of dividends.  The business may retain earnings, and not distribute earnings.  Hence, the investment may never yield a return, even in a successful business.
  5. Investors in early stage businesses may not sell their investment on a stock exchange.  As a result, investors in this type of business may have poor liquidity, even if the underlying business is highly profitable.
  6. If a business is very successful and undergoes a public offering, it is likely that the public offering will dilute the share value of the early stage investor significantly.  Offerings are dependent upon market conditions, and the market conditions at the time of the offering may not be favorable.  It is possible that an early stage investor will end up owning shares with a market value less than their purchase price.
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