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Archive for September, 2019|Monthly archive page

Investment in a start-up is not a child’s play

In fraud, General, Risk, Uncategorized on September 24, 2019 at 3:25 am

80% -90% of Start-up businesses fail in the first few years of operations. Given this data, investment in a start-up is not a child’s play. Being a Ph.D. in risk management and having studied large institutions where the failure rate is far lesser, I was always intrigued about how angel investors calculate the risk of start-ups to make an investment decision. At the same time, it would be equally difficult for start-ups to convince the investors for their potential and ability to perform.

Recently I visited the University of Southampton for my research and met an interesting lady who was an angel investor with enormous funds to invest particularly in Ghana. My questions became specific as I heard the word ‘Ghana’. Why an angel investor wants to invest in Ghana only? What motivates her to take such a decision. Very soon, the lady revealed the reasons: one by one setting a story. She taught me investment risk in a unique way, which I cannot forget lifetime.

The lady had seven children, five dogs and two visiting foxes living with her in a beautiful house at London along with her husband, who was a medical practitioner. She said, “if you are a mom/dad, it is easy to understand what an investment in a start-up means. Consider your child as your angel investment and marriage of child as an exit for the investment. Investment in Ghana was not a new idea as for a parent from Ghana just wanted the child alike”.

Similar to a promoter-based company, when you invest in your child, it is full of optimism while if it is for others (start-ups), many times, investors are not that optimistic. The concerns are raised about principal risk, return risk, valuation risk, and many others. A company may not fail to deliver the promised product or fail. The returns will be variable in frequency, time, and amount. The main difference between the two situations is about trust why people tend to trust their own child than others.

Most often, start-up makes a mistake in demonstrating why investors can trust them and those who can demonstrate, most often receive the investment. To maintain that trust, they are required to answer some what if questions of angel investors which deals with risk management.

What is new about start-up: is it a product or a service? What is the start-up target market for the product? What if you don’t find a market for your product?

How will you make your product/service profitable? Show your business plan. What are the business objectives? What if you will face issues related to higher expenses, delays in projects, labor problems, license issues, stiff competition, and testing of the product.

What if you require funds over its existing cash resources to develop market capabilities?

How is management planning to execute the business for viability and success? What if you find that management is not enough experienced and expert in dealing with it?

 How you will manage fraud, and what are the controls? What if you find that the company’s management team is involved in fraud?

Further, I met another start-up business CEO who received large funding from angel investor by just showing how he can prepare the best British tea. Angel investor asked the start-up CEO how you will address the need of the British being Indian? He argued that he knows British culture, and taste better than British and can offer a British Tea. If he likes it, he will give him funding, if not, it’s okay. Eventually, he got the funding.

Investment in start-ups requires a fair understanding of the risk management and particularly two major aspects: how to develop trust and ability to answer what if questions. Remember, trust is developed first for the team; the product comes next. It is well said,

The first-rate team with a second-rate idea will always outperform a second-rate team with a first-rate idea.”
― Brian Cohen