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What HNIs looking to invest in startups must know

Firms such as Sapient Wealth Advisors and Mitraz Financial offer clients the option of investing in start-up ventures. The returns may be quite good, but there is also the risk of losing your capital

February 25, 2021 / 09:49 AM IST

Start-up investing is gaining popularity in India. The rising number of micro venture capital (VC) funds and angel investor networks confirm this growing interest.

Financial advisors say moderate returns expected from traditional investments such as mutual funds (long-term returns of 12 percent from equity MFs), bonds and fixed deposits has made investors seek alternative avenues such as start-ups, in the hope of getting multi-fold returns on their investments.

High networth individuals (HNI) and ultra HNIs whose portfolios are adequately diversified are being asked to invest in start-up ventures by wealth management firms. The idea is to explore firms that could turn out to be the next Flipkart or Facebook at an early stage.

Pune-based Sapient Wealth Advisors and Brokers recently entered into a partnership with Venture Catalysts, which invests in start-ups as an angel investor or a micro venture capital (VC) fund. It also uses other investment formats, depending on whether the start-up is at an early stage or at a more mature stage of its growth journey.

Not suited for all

Apart from family offices and former start-up entrepreneurs, young senior executives are also showing appetite for investing in start-ups.

Also read: PM Modi announces Rs 1,000-crore 'Startup India Seed Fund'

But start-up investing is not meant for all investors. Even though the average investment required to invest in a start-up has reduced, HNIs are better-placed to handle the risks that come with start-up investing.

A start-up investor would need to set aside in Rs 5-10 lakh. Investors with over Rs 5 crore of liquid wealth are preferred as they can participate in more rounds of funding to help the start-up grow its business.

KK Ram, VP-Venture Investments at Sapient Wealth, says that it does risk-profiling of clients and offers start-up investment options only to those investors that understand the nature of start-up investments and can handle the risks that come with start-up investing.

Exiting investments not easy

Unlike traditional investments such as MFs, bonds or FDs, you cannot easily cash in on your start-up investments unless a private equity (PE) investor or venture capital fund also decides to invest in the start-up. However, this is not enough; the PE or VC fund should also be willing to offer capital for giving attractive exit to early-stage investors.

Also read: Here's how you can apply for funds from govt's Startup India Seed Fund scheme

“PEs are not always willing to give capital to facilitate exit of angel investors. There are instances where they are only willing to infuse funds if it is used for growth of the company and might only want say 20 percent of their funds to be used for buying out angel investors,” says Varun Girilal, co-founder and executive director at investment advisory firm Mitraz, which facilitates start-up investments for its clients.

“In such cases, the angel investors will have to settle for an exit at lower valuations,” Girilal adds.

Experts say you might have to wait for three years to exit your investment, though there is no guarantee of being able to do so.

Failure rates

A recent survey by The National Association of Software and Service Companies (NASSCOM) says that 30-40 percent of tech start-ups halted their operations or were close to shutting down due to the challenges caused by the COVID-19 pandemic.

Also read: Exclusive | COVID-19: Smaller Indian VCs may feel squeezed

Even in normal times, the failure rates of start-ups can be high. “Start-up investing is sometimes portrayed as an opportunity to get into the next Facebook, Flipkart or Amazon; but such investments are extremely rare. Several start-ups end up closing down due to a variety of reasons – inability to grow the business, lack of demand for their products or services, or just inability to raise funds,” says Girilal.

Ram adds that clients are made aware about the possibility of splendid returns and also the likelihood of losing their entire investment.

“We advise them to take a portfolio approach to a basket of start-up investments, which can result in failure rates (i.e. closing of start-ups) of 30 percent, 40 percent of surviving and giving normal returns, and the remaining 30 percent giving manifold returns. We tell them that they may end up with excellent returns with the top 10 percent of the investments, but this depends on the start-up’s growth, its ability to make gains on the market opportunity, and luck," he says.

Sapient Wealth also advises clients not to invest more than five percent of their investment funds in start-ups. However, if they have the experience of how start-ups work and want to invest more, they are asked invest up to 10 percent.

Large competitor can hurt your start-up

Several start-ups are from the technology sector. Apart from the common risks that all start-ups face, tech companies also face the risks of another technology company offering services that can make your start-up less attractive or worse; redundant.

For example, a Bangalore-based start-up offering cloud-based communication solutions, lost its competitive edge after another telecom company with much larger financial resources entered the space. The angel investors who earlier had an opportunity to exit with 100x returns, eventually had to settle for 19x returns.

Jash Kriplani
Jash Kriplani is a journalist with over ten years of experience. Based in Mumbai. Covering mutual funds, personal finance. His last stint was with Business Standard, where he covered mutual funds and other developments in the financial markets
first published: Feb 25, 2021 09:49 am