Investors often tread a path filled with uncertainty and information gaps when evaluating opportunities, especially in the realm of financing new businesses. Let's delve into some strategies to mitigate these investment risks.
1. Self-financing: backing your belief
Investors appreciate entrepreneurs who invest their own capital. It signals confidence in the venture's potential. The primary advantage is that the owner retains a substantial share of equity. However, self-financing may not be feasible for everyone due to financial constraints.
2. Contract provisions: safeguarding investments
Contracts play a crucial role in managing risks:
- Covenants: These are restrictions on the founder's actions, requiring investor approval for significant decisions like share transactions.
- Mandatory redemption rights: Investors have the option to reclaim their investments at any time.
- Convertible securities: These financial instruments convert preferred shares into common stocks at the investor's discretion, often providing protection during liquidation.
- Forfeiture and anti-dilution provisions: These allow investors to claim a portion of ownership if the venture fails to meet agreed milestones.
- Control rights: Investors influence how the venture's assets are utilized.
- Long-vesting periods: These restrict the entrepreneur's ability to cash out investments or leave the venture without investor consent.
3. Specialization: focused expertise
Investors often specialize in specific industries or venture development stages. They make smaller early-stage investments and larger ones as businesses mature. This specialization fosters valuable partnerships and knowledge sharing, benefiting both investors and entrepreneurs.
4. Geography-localized investing: closer involvement
Investors may localize in specific regions to facilitate closer involvement in daily operations and access to promising startups. Local networks provide insights into potential investments and trusted contacts, simplifying decision-making.
5. Syndication: sharing risk and insights
Investors can reduce risk by inviting others to join investments, spreading risk and leveraging diverse experiences and expertise. Syndication helps manage investment pressure while offering different perspectives.
Navigating investment risks demands a strategic approach, and investors employ various techniques to ensure they make informed decisions and protect their capital.
Adapted from: Baron, R. and Shane, S., 2007. Entrepreneurship: A process perspective. Nelson Education.