Recently, there was a lot of noise on social channels about the rise in the number of unicorns from India (“Unicorn” is a term used to describe a startup company with a value of more than $1 billion).
Here is one image (source) that was doing a lot of rounds:
These days even Ultra-high net-worth individuals (or UHNIs) look at startup investing as one possible option to invest their money for high returns (but with high risks).
Then every now and then, you come across anecdotal success stories about startup or angel investing. You will regularly hear statements like (you can fill in the blanks easily) – If you had invested Rs __ lakh in ________ when it was founded in the year 20XX, the value of your small investment would now be a massive Rs ____ crore today.
A few high-profile success stories of startup investing feeds the imaginations of small investors and gives them hope of getting massive returns, which in turn can be their ticket to eliminate life’s all financial worries. And this is what pokes the interest of small investors in this space. Even young salaried individuals are now showing interest in investing in start-ups.
There are no doubt the life-changing wealth-creation opportunities that startup investments provide are unparalleled. But it is also true that it is extremely risky and very few actually do well in it.
So should small retail investors in India invest in startups or get into angel investing?
Assuming it’s possible to do so legally and with regulator specified eligibility criteria (if you know the answer to the question can anyone invest in startups in India), even then I still think that startup investing is not suited for all. Really, it’s not for everyone. I personally know a lot of startup investors as well as founders, and I can say this with confidence that it’s not for everyone. It appears rewarding and looks glamorous from the outside but the reality is different once you deep dive into space. The risks far outweigh the gains for the small investors.
There are numerous data points that show that very few startups actually succeed. The failure rates in startups are very high. It won’t be wrong to say that it would be close to 70-80% or around that figure. This means that there is an 80% chance of losing your entire investment when investing in startups.
And startup success in itself does not translate into profits for investors. It’s much more complicated than that.
Have a look at this statistic (via this tweet which is based on a study here).
As you can see, it gets really difficult for startups to continue raising money. And that is imperative if investors of startups want to eventually (someday) want to make money.
Now from the investors’ perspective, how will he/she make money on startup angel investing?
It is about finding opportunities to cash out from investing in startups. And there are just a few options to do that as far as I understand the space:
- The startup is acquired by another company/startup
- The startup goes for an IPO
- Investors sell their shares to other investors in the next rounds
- The startup becomes profitable and begins paying dividends. On a related note, read How to live off Dividend Income in India?
Most common investors focus on the 3rd option. i.e. “existing investors sell their shares to other investors in next future rounds.”
But exiting investments isn’t easy.
For you as an investor to get an exit, there needs to be a buyer on the other side. And unless VCs show an interest in the startup you have invested in, you will find it exceedingly difficult to exit your startup investments. Also, the next round of investors or PE/VC funds should also be willing to offer attractive exit to early-stage investors. Right? And in general, many aren’t always willing to facilitate the exit of early investors. They at times are more interested in infusing funds into the startup for its growth. So if that’s the case, the early investors might have settle for an exit at lower valuations. So this in itself limits the ability to exit profitably.
Also, one may have to wait for years to exit the investment. And yes, there is no guarantee that it will actually happen. Remember the high failure rates of startups.
So…
Are startups a good investment?
Yes, if you get it right. But the probability is very very low. I repeat it’s extremely low. Also, it’s not suitable for everyone. More so for the small investors who have limited capital to invest (plus, assuming they are eligible for it).
HNIs and ultra-HNIs who already have large diversified portfolios in other assets may still consider investing a small bit (like 5-10% of their portfolio) in the startup space.
And there is another angle to this.
If you plan to invest in just one or two startups, then it’s just like buying lottery tickets. Most large startup investors follow a portfolio approach where they invest in multiple startups. The idea is to invest in many, then allow a few to fail completely, allow several to do ok’ish’ and finally, just 1 or 2 doing really very well and taking care of the need to generate mega eye-popping returns.
And since common investors do not have the financial bandwidth to invest several lakhs of rupees in multiple startups, it can be said that start-up investing is not meant for all. These days, due to some platforms offering smaller entry options, the average investment required to invest in a start-up may have reduced. But that still doesn’t change the dynamics of risk-return of this highly risky investment avenue.
So for small investors, it’s a case of not playing around too much with their hard-earned and limited money. Startup investments do provide disproportionate wealth creation opportunities. But there is a high chance of losing the entire investment in most cases. Another downside is that money gets locked indefinitely. It’s not like mutual funds or stocks where you can exit when you want and get your money in a day or two.
If you are a small investor who is getting a bit excited about startup investing, then I would suggest first get your basics right – like have an emergency fund in place, know what your real financial goals are (like children’s education and future, house purchase and retirement planning), and invest sufficient amount for these goals regularly via SIP in equity and debt funds.
Once you have ticked off these boxes, and have some more surplus left, you can even (first) consider investing in PMS (again that is something not suitable for small investors).
Only then startup investing should come on the discussion table.
I hope that now, you know about the pros and cons of investing in startups in India.
Also, when finally getting into startup investing somehow, do not invest more than you can afford to fully lose in any single investment.
You might be tempted about it as investing in startups is trending. But making money here is tough. So If you are a small investor and have no access to the big investors who ‘know things’ then avoid startup investing.
As for the unicorn $1 billion dreams, I leave you with a tweet (link) by a well-known founder:
Unicorn tag, high valuations are all vanity metrics till the company delivers profits. Many companies like Amazon & Facebook were loss-making for several years but became truly valuable only when they delivered profits. Till profits, ‘unicorns’ are the hope and belief of its stakeholders.
Related reading – LTCG surcharge capped at 15% for all assets including long term startup investments
For small investors in India, it’s not about how to invest in startups. Rather it is about should they invest in startups.
And the answer is (I am sorry to disappoint), a… No!