Investing remains essential to personal financial freedom and security, especially when done using best practices. While the importance of investing is well and truly established, an understanding of investing across different asset classes (I.e. stocks, bonds, commodities, startups, etc) together with what the role of an investor during the investing process isn’t.
In the last couple of years in Africa, for example, there has been an explosion of activities happening in the Venture Capital and Startup space in terms of funding, expansion, and reach, with startups like Paystack, Flutterwave, and Andela being some of the success stories of the ecosystem. Their success has inevitably triggered consumer interest in investing in the next big thing.
This article aims to provide a rational and measured approach to what investing in startups is about and how new and existing investors need to approach investing in this unique asset class s to increase their chances of positive returns.
Finally, this article aims to provide you with the exact role of an investor in any investment process which is simply to be an allocator of investment funds.
Outline
- Investing in A Nutshell
- Startup Investing And Its Uniqueness
- The Role of An Investor in any Investment Process
- Conclusion
Investing in A Nutshell
In simple terms investing can be described as the process or act of allocating resources (i.e. capital or money) towards an asset class with the end result of gaining returns, income, or profit over a duration of time.
In practice, investors tend to use two basic investing strategies which most times can be tagged as Value Investing and Growth Investing. Value Investing as a strategy involves focusing on the fundamentals and value that an asset class offers and is a strategy adopted by famous investors such as Warren Buffett, Benjamin Graham, John C. Bogle, Joel Greenblatt, Charlie Munger, Seth Klarman, Michael Burry, and Bill Ackman.
Benjamin Graham who is the father of value investing and known for spearheading this strategy is quoted as describing an investment as thus “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.”
Growth Investing as a strategy involves investors keenly focusing on an asset class’s price appreciation. Most times growth investors have no need to assess the intrinsic value of an asset class and are keener on the potential of an asset to grow at a better pace and yield higher gains way above the profits of an existing industry. Famous growth investors include the likes of Cathie Wood, Peter Thiel, Philip Fisher, and Thomas Rowe Price Jr who is the father of growth investing.
A key element of investing is the type of asset classes in which an investor invests. An asset class represents a grouping of investments and securities which tend to have similar characteristics and behaviors in a particular marketplace.
Examples of common asset classes include stocks, bonds, cash, alternatives, real estate, and commodities. Each asset class usually has its own risk, return, and liquidity profile which is unique and different from the risk, return, and liquidity profile of other asset classes as described in Figure 2 below.
Startup Investing And Its Uniqueness
In the last couple of years, investing in startups (which tend to fall under the alternative investment asset class) has become an attractive and profitable proposition for many investors. Startups are basically companies that are in their early stage of development and seek to bring a very innovative approach to any industry. Startups usually tend to stretch across many sectors ranging from healthcare, commerce, finance, agriculture, etc, and in the fourth industrial revolution which we live in, technology. .
As an investment, startups offer investors high growth and return on investment at high-risk (According to CBS Insights 95% of startups fail for numerous reasons) and the typical type of investors who invest in them fall under the private equity, venture capital, and angel investing space.
Over the past 5-6 years in Africa, there has been an explosion of activities in the startup and venture capital space which has seen funding in excess of $5 billion in 2021 into the ecosystem. This progress in the space has led to top startups who have become household names such as Piggyvest, Flutterwave, Paystack, Jumia, Reliance Health, etc, further driving consumer interest in startup investing from a broader population of investors home and abroad.
According to Partech, VC funding in 2022 for the African tech ecosystem grew by 8% to US$6.5B, through 764 rounds, with debt funding doubling in the year (+102% to US$1.5B in 71 rounds) to compensate for a slight decline in equity rounds (-6% to US$4.9B in 693 rounds).
The growth in the space has produced different funds, syndicates, and funding platforms as startup investing options for both accredited and non-accredited investors some of these options include the likes of Microtraction, HoaQ, Berrywood Capital, GetEquity, Ingressive Capital, etc. who combined are helping to drive liquidity into the growing startup ecosystem.
Investing in startups is quite unique and regardless of the nature of the startup’s funding stage (i.e. pre-seed, seed, Series A, Series B, etc.), there are qualitative and quantitative components to factor into consideration before coming to an investment decision.
These components include;
- Founders and Team: Here, investors should be interested in knowing the background, expertise, and motivation of the founders and team with regards to building a startup. Also, the founding team should possess complementary skills and the ability to execute.
- Product: Here an investor should be interested in understanding the value proposition of the product or services a team is building and what utility it would give to potential customers. It is also important to review the investment opportunity as part of a big picture, giving consideration to the existing competition and figuring out why this opportunity stands a chance.
- Market: Here an investor should be interested in understanding the nature, size, and growth potential of the market the startup operates in. Also key to understanding is the startup’s competitive edge in relation to other startups which operate in such a market.
- Business Model: Here an investor should be interested in evaluating and understanding how the startup intends to make money (i.e. revenue streams) and the likelihood of additional revenue generators in the future. Also key would be understanding how it aims to get customers exposed to its value offering.
- Traction: Here an investor should be interested in knowing how well the startup is performing in terms of the availability of a minimum viable product (MVP), its number of (active) users, revenue, financials, and other relevant KPIs.
- Valuation: Here an investor should be interested in the value of the startup which is important because it will determine what their ownership stake would look like if they go ahead to invest. There are many valuation methods used to evaluate a startup depending on its stage of development. Some useful methods include the Scorecard Method, Venture Capital Method, and Discounted Cash Flow Method.
The Role of An Investor in any Investment Process
Quite simply, the paramount role of an investor in the investment process is to be an allocator of their investment capital. This means that capital allocation across asset classes should always reflect your investment temperament when it comes to investing and risk-taking (i.e. conservative, moderate, aggressive) you should allocate your capital to different asset classes based on their different risk and return output.
As earlier stated, different asset classes usually have their different risk and return outputs attached, with some assets being way riskier than others but yielding little return and vice-versa. For example, fixed-income securities (i.e. bonds, treasury bills, etc.) tend to be low-risk and low-return asset classes, while stocks, commodities, and alternatives tend to be much more risky asset classes with the potential of offering higher returns.
To elaborate on investor asset allocation in more clear and practical terms, let’s say you have investment capital of about ₦100,000 which you intend to deploy to multiple asset classes such as bonds, stocks, and alternatives (i.e. startups). Considering whether you are a conservative, moderate or aggressive investor, your allocation model should look like the table below:
Table 1. Basic Investor Asset Allocation Template
Conclusion
To close, it is critical to note that there are numerous reasons why understanding the value of asset allocation across different asset classes is so important today. Chief among them is that with investing the risk of losing all your investment capital is quite real and thus diversification and proper allocation as an investor helps mitigate such risk.
Startups have become an exciting asset class to the modern and young investor (i.e. GenZ and Millenial), and while they offer the prospects of great rewards, it is vital that the best-investing practices apply when one is making an investment decision.