GetEquity Blog

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:

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.

Hi There,

I think by now, you are very well aware of startup investments being a high risk venture to say the least. Not every business becomes successful. In fact, many professionals in the industry will tell you that 90% of startups fail.

This article isn’t meant to dissuade you from the path of investing. History has shown from time to time that investing can ALSO be high reward as well. However, because of the high risk nature of it all, the statement “Do not put all your eggs in one basket” applies greatly here.

In startup investing, diversification is KEY. By Investing in a variety of companies, you minimize the risk involved and maximize your chances of reward. If one investment fails, you don’t lose all your funds in one sitting.

Benefits of a diverse portfolio

• One benefit you get when you diversify is that it allows you invest in different types of companies. Companies that are at different stages of development(pre-seed, seed, series A) and even different industries(health tech, fintech, edutech, tech media, agribusiness, construction, logistics etc). These industries are ever changing and growing and usually attain success at different points in time.
• Another benefit is that it increases your knowledge base of the business world and life in general. It is on you to ensure due diligence is done on the different companies you intend to invest in. This in turn allows you to learn more about the businesses, the type of industry they are in, and the industry’s past and future prospects. This comes with the possibility of becoming a knowledge expert in more than 2 of these industries which will inform not just your investing decisions but decisions you might need to make as a consultant, founder or employee.
• Diversifying your portfolio means getting the chance to meet different people across industries. This allows you to build a more meaningful and diverse set of relationships with not just startup founders but fellow investors as well. Your network they say is your net worth. What better way to build this than a diverse portfolio.

Now that you understand a few of the benefits, what are the key things you need to consider when choosing to diversify:

First, your investment goals

Have you considered these questions before making a choice to invest:

• What are you trying to achieve through investing?
• How much risk are you willing to take on?
• Why do you want to invest in company A?
• How long do you want to be an investor? is this a 5-7 year plan or a 10-20 year plan?

Once you have a clear answer to these questions, then you can make an informed decision to distribute your investments.

Secondly, due diligence

The importance of due diligence can not be overemphasized. Have you done adequate research?

What do you know of the startup’s management team, its financials, its market, and its products?

Are there any red flags you’ve noticed on the legal or financial side of things?

What is the market like? and what are the startup’s financial projections?

The extent of due diligence done on each company can make or mar the prospect of your investment.

Additionally, Do you understand the terms of the investment you are making? A founder may offer equity or convertible debt and its important to understand what that means for you as an investor

In conclusion, here are a few tips for having a diverse portfolio:

• Invest in companies across different industries.
• Invest in companies across several stages of development
• Invest in companies across different geographical areas
• Review your portfolio regularly with time.

Investing in startups can be a rewarding experience but never forget to balance out your risk.

Till next time,

Tolu