Investment in equity securities of startups is accompanied by certain risk factors. Every investor (Investor) should be aware that an investment in a startup company (Startup) involves a high degree of risk. There can be no assurance that (i) a Startup will achieve its business plan. or (ii) an Investor will recover or receive any return on any part of its investment.
The following considerations, among others, should be carefully evaluated before making an investment in a Startup:
- Loss of Capital: Investments in startups involve a high degree of risk. The market in which the Startup operates may be highly competitive and it is unlikely for a Startup to survive and prosper in the long run. There is no guarantee that any Startup will succeed and it is more likely that the Investor may lose all the invested capital than see a return on capital or a profit. Therefore, it is very crucial for the Investor to analyze and gauge the risks that are involved with investing in a Startup and shall contemplate and be familiar with any and all shortfalls that may arise including unexpected problems in the areas of product development, manufacturing, marketing, financing, and general management that a Startup investments often experiences.
- Rarity of Dividend: Startups may not have the capital/ tolerance to pay dividends. Startups generally prefer to reinvest the profits, if any, to grow and build market value. This means that if the Investor invests in a Startup, the Investor is unlikely to see any return on capital or profit until the Investor is able to sell its shares in the Startup. Even for a successful Startup, dividend pay-outs may be unlikely for a number of years from the time the Investor makes the investment.
- Changing Economic Conditions: The success of any investment activity is determined to a certain extent on general economic conditions. The availability, unavailability or unhindered operation of external credit markets, equity markets, stability in global economies, etc. in which an individual Startup depends, may have a significant negative impact on a Startup’s operations and profitability. The stability and sustainability of growth in global economies may be impacted by terrorism, acts of war or a variety of other unpredictable events. There can be no assurance that such markets and economic systems will be available or will be available as anticipated or needed for an investment in a Startup to be successful. Changing economic conditions could potentially, and frequently do, adversely impact the valuation of the Startup.
- Future and Past Performance: The past performance of a Startup or its management cannot be a means to evaluate its future results. There is no assurance that targeted results will be achieved. Each Startup’s future statements are based on management's current expectations and assumptions regarding the Startup’s business and performance, the economy, etc. As with any projection or forecast, forward-looking statements are inherently susceptible to uncertainty and changes in circumstances. Generally, Startups do not have operating history
- Difficulty in Valuing startup Investments: It is difficult to determine objective values for any startup. In addition to the difficulty of determining the magnitude of the risks applicable to a given startup, there generally will be no readily available market for a startup’s equity securities, and hence, an investor’s investments may be difficult to value.
- Lack of Information for Monitoring and Valuing startups: The Investor may not be able to obtain all necessary information it would want regarding a particular Startup, including the current value, on a timely basis or at all. It is possible that the Investor may not be aware on a timely basis of material adverse changes that have occurred with respect to certain of its investments.
- Diverse Investors: Investors in a Startup may have conflicting investment, tax, and other interests with respect to Startup investment, which may arise from the structuring of a Startup investment or the timing of a sale of a Startup investment or other factors. As a consequence, decisions made by the management of the Startup or other Investors on such matters may be more beneficial for some Investors than for others.
- Minority Investments: A significant portion of an Investor’s investments will represent minority stakes in privately held companies. As is the case with minority holdings in general, the Investor will neither have control over the management of the Startup nor will they be given valuation premiums as is enjoyed by the majority or controlling stakeholders. In such cases, the Investors will be reliant on the existing management and board of directors of such companies, which may include representatives of other financial investors with whom the Investor is not affiliated and whose interests may conflict with the interests of the Investor. Investors in a Startup will not make decisions with respect to the management of the Startup, or other decisions regarding such Startup’s business and affairs.
- No Assurance for Additional Capital: After an Investor has invested in a Startup, continued development and marketing of the Startup’s products or services, or administrative, legal, regulatory or other needs, may require that it obtain additional financing. Such additional financing may not necessarily be available on favorable terms, or at all.
- Absence of Liquidity: An Investor’s investments will generally be private, illiquid holdings. As such, there may be no readily available liquidity mechanism available for any of the investments. In addition, an investment in a Startup will not be freely transferrable, and involves a high degree of risk and low liquidity and should be viewed as aggressive long term investments. There is no public market for securities in a Startup until such Startup conducts an initial public offering, and it is not expected that a public market will develop. Consequently, an Investor will bear the economic risks of its investment till such time as it holds securities in the Startup. This means that the Investor is likely to see a return only upon the occurrence of a liquidity event or an exit. Therefore, understanding the exit strategy of a Startup is important.
- Withholding and other Taxes: There are many tax risks relating to investments in Startups. The structure of any investment in a Startup may not be tax efficient for any particular Investor, and no Startup guarantees that any particular tax result will be achieved. In addition, tax reporting requirements may be imposed on Investors under the laws of the jurisdictions in which Investors are liable for taxation or in which the Startup is located. Investors should consult their own professional advisors with respect to the tax consequences while investing in a Startup under the laws of the jurisdictions in which the Investors and/or the Startup are liable for taxation.
- Regulatory Risks: The investment may be subject to applicable laws of the Investor’s country of residence as well as the country where the relevant Startup is registered. The growth in the market value of the Startup may depend on the regulatory environment and a change in applicable laws to the Startup or the Investor may adversely affect the valuation of the investment, the ability of a Startup to succeed or the ability of an Investor to recover or obtain returns on his investment. The Investors are advised to seek adequate legal advice to familiarize themselves in this relation, prior to making investments in Startups.
- Confidential Information: Certain information regarding the Startups will be highly confidential. Competitors may benefit from such information if it is ever made public, and that could result in adverse economic consequences to the Investors.
The foregoing risks are only indicative in nature. It is recommended that you seek independent legal and tax advice and read the relevant investment documents carefully before investing in a startup.
