Starting your business is an incredibly risky and difficult endeavor. Still, the number of start-ups keeps going up every year. The exhilarating and powerful feeling of being your own boss, coupled with the excitement of creating something new from scratch, motivates numerous enthusiasts to start their own business. This can be ascertained from the fact that even when the world was going through a global pandemic, start-ups received more funds from venture capital firms than ever before.

Investing in startups, or Venture investing, as it is commonly called, is a trending investing approach. When you are an investor in a startup or venture, you may either buy an equity stake in the business or lend money to the company in its inception stage itself. Investing in startups comes with its own set of risks and uncertainties. It is very different from investing in listed stocks. You will not find an established or standardized financial metric or customized fund commentary to calculate the risk before making an investment decision regarding start-ups. Therefore, it is important to understand the risks that are involved in being an investor in startups. Let’s have a detailed look at the risks of being an investor in startups:

Risk of the unknown: The primary risk of venture investing is that you are investing your money in something that has yet not been tried and tested. This requires the vision and knowledge of investing in an idea that is yet not in existence. It requires a deep foresight and a huge risk appetite. You can either show faith in your instinct or base your investment on familiarity with one or several promoters of the business.

Risk in execution: Since the business is still an idea, there is no way to assess its success or failure. Chances are, that you would be new to the industry and would not understand the dynamics of the business. Several businesses start as a great idea but fail at the execution stage. The business idea of the startup may be simply a lift-off from an existing business. If the business owners fail to add some unique and concrete features to the idea, which make it stand out from similar existing businesses, there are high chances that the business would not succeed even after a great execution.

Risk of lack of exit options: Once you invest in a startup, you cannot redeem or withdraw your funds until there is a formal stake selling or re-funding. You cannot sell your startup investment in the secondary market on various exchanges and would have to hold on to it till the startup gives you a voluntary exit. This leads to a lack of liquidity in venture investing.

Risk of delayed returns: Return on investment in startups may take several years to come through. Generally, startups take 2 to 5 years to generate returns, if they ever happen. You might even not get to know for many years if your investment would give any return at all or not. If you require a return soon, investing in startups may land you in trouble.

Risk of change in plans: Several factors that affect the business environment of the startup would affect your investment in it. A change in the product line or the company, technology going obsolete, possible lawsuits, and change in government regulations for the business and the industry it belongs to, would all contribute to the returns you get from the business.

Risk of dilution: Startups usually raise additional capital through multiple funding rounds. If the type of investment opportunity in these future rounds is such, the business may pass on a share of the company’s equity to these new investors. This would lead to the dilution of the share of ownership the initial investors hold currently. It may also be an opportunity loss for the initial investors who in all probability, invested in the business on less accommodating terms.

Investing in startups offers unlimited return opportunities. Your investment may grow by leaps and bounds with a growth a new business witnesses. However, you need to have a strong risk appetite and enough free funds to invest in new businesses and reap the benefits it could bring to you.