Most High Networth Individuals (HNIs) have a portfolio that is adequately diversified. With traditional investment options, the returns are limited. Investing in mutual funds and direct equity can deliver an average return of 12%. Some HNIs are looking for a beta to get super-high returns. They are ready to take extra risks for it. At Right Horizons, we help HNIs to explore an emerging avenue – investing in startups. They should look to invest in companies that could be the next Flipkart or Zomato. Since it comes with its own risks, it is important to carefully chose your investments in the startup space- both at a company level and at a fund level.
Indian start-up landscape
The main reason investing in startups is becoming popular in India and is being considered by many HNIs is because of the success Indian startups have seen in the last decade. Today, India is the world’s third-largest start-up ecosystem behind the US and China. We have more than 60,000 startups that have attracted investments from across the globe. More and more capital is flowing into the Indian start-up ecosystem, which leads to funding, and more exits and wealth creation for investors.
A recent Goldman Sachs report states that in the next 3 to 4 years, more than 150 private companies can go public. There is a significant opportunity for investors willing to take a risk and explore new investment avenues.
Investing in startups: Risk-reward game
Before you invest in startups, it is crucial to understand their risk-reward equation. The equation is different from mutual funds or direct equity.
Risks: The major problem with start-up investing is that 90% fail. You may not even recover the capital you invested in them. Several close down for various reasons – lack of demand for their products or services, inability to grow the business, or just inability to raise funds. Also, start-up going public is a long process – you need to wait for years. Your investment in between is relatively illiquid. To make the process smoother, you can consult a financial advisor and understand the liquidity aspect of your investments.
Reward: If you invest even in one start-up that turns profitable and goes for a public listing, the wealth creation would be massive. Assume someone had invested Rs 10 lakh in Zomato during their first round of angel funding in 2010. At the time of listing, you would have been holding Rs 150 crore worth of Zomato shares – a massive gain of 1500 times. However, an essential point to understand here is that Zomato was not a brand in 2010, and investing a substantial amount at that time was a huge risk. Secondly, staying invested for over a decade is an art. Financial advisors can guide you in this journey.
Is this the right time for HNIs to invest in startups?
Below are some reasons we believe it is the right time for HNIs to explore investing in startups:
- Through Alternate Investment Funds (AIF) regulation, SEBI has made it easier for HNI investors to invest in Department for Promotion of Industry and Internal Trade (DPIIT)-recognized startups.
- Big businesses like Tatas and Reliance have started investing in scaled-up startups. It gives other investors the option to make an early exit in these startups.
- The startups have started coming up with their IPOs, which is encouraging for investors.
- Liquidity is a major problem with start-up investment. It is getting solved as secondary transactions have increased. Large equity lots are available to HNIs and UHNIs, both for buying and selling.
- Some Private Equity (PE) funds have started to look at investing in tech startups. It has increased the activity levels in the ecosystem.
- An ecosystem of angels has got built over the last few years.
- A number of promoters of startups have got large exits in their companies and most of them invest a good part of their windfall into startups.
Investing in startups has become relatively easy now. Even retail investors are exploring the option. However, HNIs are better placed to handle the risks that come with investing in startups. Ideally, one should not invest more than 5% of their total capital in high-risk investment avenues like startups. Also, getting in touch with a financial advisor before you invest your money in this avenue would make a lot of sense. They can guide you at what stage you should invest to maximize gains and reduce the risk.