How to securely invest in Start-Ups, why is Enhanced Due Diligence important and what to do
The high expected returns are an important reason why people invest in startups, but that’s not the only motivation.
The average financial returns from startup investing are higher than those from public equity markets. Over 20 years, venture capital returned 11% annually (net of fees and carried interest) versus 7.5% for listed equities, according to Cambridge Associates.
Most private investors don’t have access to venture capital funds because they lack the large investment sums (usually a million or more) to get into these funds. But there are opportunities for private investors to make direct investments in startups, be it through business angel networks, microfunds with smaller entry tickets, or investment platforms.
I Informed decision-making when investing in Start-Ups
When it comes to startup investments, are people just betting or taking an informed decision? Getting good information in private markets is hard work, but essential for success. At any moment in time, there are thousands of new companies in Europe looking for fresh capital. Some of them will turn out to be fantastic investments, others not so much. Because the returns in venture capital are quite dispersed (this means that investors might lose it all on one investment and make ten times their money on another), it makes sense to build a portfolio and look at as many investment opportunities as possible. There’s a marked difference between screening a lot of startups in order to identify the rare gems and just investing in what crosses one's path.
A common error of many investors who start looking at private companies is to get excited too easily: They hear about a deal, maybe from a colleague or friend who is an investor in that company, and, without evaluating alternatives, jump right into it. If that investment turns out to be a dud, they might get discouraged and decide that this space is not for them. If they continue their journey, they automatically get more selective and, hopefully, more successful over time. Talking to many of the entrepreneurs and delving into many more business models sharpens the capacity to discern between the excellent and the mediocre. It’s sound advice not to rush the first startup investment. But then again, at some point, investors need to write their first check in order to get started. Investing in startups, as opposed to just betting on them, means making informed choices about what sort of uncertainty and risk one is ready to embrace.
II The cost of information and digging deeper in Start-Up
One of the main differences between public and private markets is the availability and cost of information. A big listed company publishes annual and quarterly reports. The press covers it regularly, and several financial analysts write in-depth research reports about it. There’s a stock price to watch, which tells people about the expectations of the financial markets. The most important point is that people are well aware of this company. Investors still need to expend time and have the knowledge to digest this information and interpret it. But once they’ve made up their minds and the valuation looks attractive, they can invest in a blink of an eye.
The situation of a startup in its early stage is different. The founders might be ready to change the world, but in terms of visibility, they start from nothing. Investors must somehow become aware of this opportunity. Having a network of sources that provides this access is commonly referred to as “deal flow.” The more connected a startup investor becomes, the more deals they’ll find out about. But deal flow is proprietary, and it’s earned over time. For investors who just started and are not plugged into the startup ecosystem yet, this deal flow will be a trickle at best.
III What is Enhanced Due Diligence (EDD) on Start-Ups
Enhanced Due Diligence (EDD) on start-ups refers to a more thorough investigation process that investors or other parties undertake to evaluate the risks associated with investing in a particular start-up.
EDD goes beyond the standard due diligence process and involves a more detailed analysis of the company's financial, legal, and operational aspects. This includes an assessment of the start-up's market position, business model, management team, intellectual property, regulatory compliance, and potential legal and reputational risks.
The purpose of EDD is to identify any potential red flags or areas of concern that may affect the success of the investment. EDD can help investors make more informed decisions about whether to invest in a particular start-up, and if so, what the appropriate level of investment should be. It can also help investors to mitigate any risks associated with the investment and ensure that they are well-informed about the start-up's operations and risks before committing any capital.
Investing in startups poses several challenges. There are global investigative & business intelligence companies as well as Swiss Wealth Advisors which addresses many of these challenges by providing a constant stream of information and data needed for informed decision-making with preventing of Loss and Risk mitigation. This solves several problems that investors face when venturing out on their own:
1) Lack of complete picture
2) Lack of experience in assessing startups
3) Lack of Information
4) Lack of time
5) Lack of access
6) Lack of proximity
7) Lack of competence