Investing in private market startups can be an exciting way to diversify your portfolio and support innovative companies. However, it’s not for everyone. Startups are inherently risky, and many fail or never deliver returns. Therefore, understanding your risk tolerance before investing is important before diving into this asset class. In this blog, we’ll discuss various factors investors should consider in order to begin exploring your risk tolerance.
Find Your Risk Tolerance
Assessing your risk tolerance is a very personal thing – it’s one person’s attitude toward how well they may be able to stomach loss. Two people could be the same age and have the same experience, net worth, and financial situation, but have two completely different risk tolerances. With investing being inherently risky, evaluating your own personal risk tolerance is something you should explore before ever making an investment.
Unlike public markets, where you can buy and sell stocks instantly, private market investments are illiquid. You may need to hold your investment for years before seeing any returns—if at all. Additionally, startups are high-risk ventures; 90% of startups fail. Assessing your risk tolerance can help you determine whether you’re prepared to handle these challenges.
Assessing Your Risk Tolerance
The following are some key considerations investors may want to evaluate in order to assess their risk tolerance.
Liquidity Needs
Liquidity refers to how quickly and easily an asset can be converted into cash. A bank account/cash is the most liquid, as it does not take a lot of time or effort to access the capital. Alternatively, a real estate investment like a primary residence is significantly less liquid due to the time and effort it could take to sell the house and receive proceeds, if any, from the sale.
Some questions an investor may want to ask include:
- How important is it for you to access your funds quickly?
- Do you need access to funds in the short term for things like unexpected expenses or job loss?
- Are you comfortable locking up funds for a long period of time?
Holding Time
Holding time is considered to be the period of time between when an asset is purchased and when it is sold. Typically, an instrument like a company’s public stock can be held for a short amount of time with the availability to liquidate or trade it on a stock market. While a startup investment may be required to be held for longer periods of time until a buyer is found in the private market , the company fails ,or an exit event occurs.
Some questions an investor may want to ask include:
- How long are you willing to hold your investment?
- Are you hoping to see returns (if any) quickly or are you willing to hold the investment for a longer period of time?
General Risk Appetite
General risk appetite is the overall level of risk a person is willing to accept to achieve their investment goals. Willingness or unwillingness to accept risk may also be an inherent personality trait.
Some questions an investor may want to ask include:
- How comfortable are you with the possibility of losing your investment?
- How would you react if your investment lost 20%, 50%, or even 100% of its value?
Age/Stage of Life
Your age and stage of life can also play a role in risk tolerance level. Younger investors may have a longer time horizon and could afford to take on more risk. However, younger investors may not have the financial situation to fall back on or stomach a complete loss of investment.
Some questions an investor may want to ask include:
- What is your current age and stage of life?
- Are you just establishing yourself in your career?
- Are you looking towards buying a house or paying for child(ren)’s tuition?
- Are you later on in your career and looking towards retirement?
Diversification
Diversification is important in any investment, it involves spreading your investments across various asset classes, industries, and geographic regions to help mitigate overall risk.
Some questions investors may want to ask include:
- What does your existing portfolio look like? What is the distribution of risk in my portfolio?
- How much of your portfolio are you willing to allocate to high-risk investments like startups?
Financial Stability
Financial stability is your overall financial situation. Understanding where an investor is currently at may uncover realities about risk tolerance.
Some questions investors may want to ask include:
- How often do you worry about money and paying your bills?
- Do you have enough liquid capital to cover unexpected situations?
- Do you have an emergency fund of 3-6 months of living expenses?
Levels of Risk Tolerance
Once your goals, timeline, and other factors have been evaluated, you may identify yourself in one of the following three categories of risk tolerance.
Low Risk Tolerance
A lower risk investor typically values a fairly stable account balance and is not able to stomach loss at a large scale. Investing in higher-risk investments may not be the right choice for a more conservative investor. Capital preservation may be prioritized over the potential of growth and the potential for loss may outweigh the potential for reward.
Medium Risk Tolerance
A medium risk investor may be comfortable with some level of risk, but stability and liquidity could also be factors that play into investment objectives and goals. Medium risk investors may allocate a small portion of their portfolio to high-risk investments but may prioritize more stable financial instruments in their investment thesis.
High Risk Tolerance
The final category is an aggressive investor with a higher risk tolerance. Investors with a high-risk tolerance may be comfortable investing in higher-risk investments for the potential of high returns. They may also be comfortable with illiquidity and long holding periods, and have a strong financial foundation and a solid understanding of the markets.
Final Thoughts
Only you can assess your own risk tolerance. It is a very personal assessment that should be done thoughtfully, carefully, and with the help of a financial professional. You will not be able to fully understand your risk tolerance from the internet, but this may be able to start your conversations with a financial professional who can conduct a comprehensive risk tolerance assessment for you.
Above all, never invest in something you don’t fully understand. You should always assess the risks of any investment, compare them to your personal risk tolerance, and make an informed decision. At the end of the day, investing in startups is very high risk and should not be taken lightly.
Are you ready to invest in startups? Sign up for a MicroVentures account start investing!
Want to learn more about investing in startups? Check out the following MicroVentures blogs to learn more:
- How to Value Startups: The Berkus Method
- Beyond Tradition: Alternative Investments
- Navigating the Risks: Why Startups Fail
- Primary vs Secondary Investing
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[5] https://www.malwarebytes.com/company
[6] https://www.securityweek.com/malwarebytes-raises-100-million-vector-capital/
[7] https://www.prnewswire.com/news-releases/malwarebytes-reports-record-growth-in-annual-recurring-revenue-expanding-customer-focused-product-portfolio-in-2020-fiscal-year-301093529.html
[8] https://www.hackerone.com/company
[9] https://techcrunch.com/2022/01/27/hackerone-series-e/
[10] https://www.hackerone.com/
[11] https://www.prove.com/about
[12] https://www.prove.com/blog/prove-identity-secures-40-million-in-funding-led-by-massmutual-ventures-and-capital-one-ventures
[15] https://www.finsmes.com/2023/04/id-me-raises-132m-in-series-d-funding.html
[16] https://www.prnewswire.com/news-releases/more-than-60-million-americans-enrolled-with-idme-to-safely-verify-their-identity-online-302221204.html
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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.
