For sophisticated investors, startups are a route towards a more diverse portfolio and potentially strong returns.
Unlike stock market and property interests, they also give investors an opportunity to influence their development and long-term success.
A seasoned business expert, who may have their own entrepreneurial success behind them, is a valuable asset to a startup – and not just because of their cash injection.
They can be a sounding board for ideas, decisions and dilemmas – and offer solutions that remove barriers to growth.
To make a success of startup investment then, should you only work with businesses in a sector you have experience of?
Stick or twist?
The many prolific business angels who choose to take their portfolios into a range of industries would suggest not.
Exploring new sectors and working with the entrepreneurs that frequent them is not just an interesting adventure. It is also a strategy that delivers diversity and balance to their portfolios.
Of course, many investors are drawn to the sectors they are most familiar with, especially as they first get involved in startup investment.
Pulling up trees
Often, investors are lured by the chance to see their old domain revolutionised, or perhaps shaken up a little.
Startups are often in the business of disruption. The founders may believe they have discovered a new take on an existing sector, and might even have the skills to make it work.
On rare occasions, their plans involve the creation of a completely new market segment. Or, at least, their offering could be almost unrecognisable from the sector norm.
Uber’s revolutionising of the taxi industry and Airbnb’s achievements in turning the hospitality market upside-down are two prime examples.
In neither startup’s backstory is there a grizzled veteran of the industries they would go on to disrupt.
But investors from the established order of the target sector can indeed play an important role in supporting startups with disruptive intentions.
Of course, they may well have been institutionalised in the ‘old’ ways of doing things, and have a very different viewpoint from a fleet-footed startup hellbent on revolution.
But conversely, their experience could be hugely valuable. If they have arrived at enterprise investment after years of success working in a particular field, they could be well versed in the flaws of the status quo. They too may have longed for a different approach. Perhaps they have watched in frustration as innovation spend has been stifled in pursuit of profits in the here and now.
Knowing the inner workings of how the other players in the sector operate gives the startup a significant advantage as it bids to overthrow the market dominators.
Not all startups are wholly disruptive, meanwhile, and the value of your sector experience as an investor may be more obvious. The startup may simply be aiming to secure a share of a growing market without having to overthrow an all-powerful leader.
Financial technology – or fintech – is one such market that has grown rapidly in recent years, generating many opportunities for ambitious enterprises.
Investment-hungry entrepreneurs in this space may seek an investor with a track record of commercialising new products and services generally. Understanding the fundamentals of entering a new market or dealing with the pains of growing a business may also be sought after.
If your background is corporate, rather than entrepreneurial, your experience could still be highly relevant.
The startup may aspire to build a multinational empire. Your expertise could enable the management team to instil the professionalism found at all levels of well-run corporations.
Outsider looking in
If you are considering an investment in a startup from a sector beyond your experience, your position as an outsider could actually be a positive.
Entrepreneurs are often so deeply entrenched in their particular market that the bigger picture eludes them. Looking at the business from the outside in brings a fresh perspective that could help to solve problems and expose previously unseen flaws.
Experience is welcome, but not a necessity
The investor’s input depends on how involved the arrangement is. While some choose to be silent investors that remain on the side-lines, others want to play their part in helping the startup flourish.
But ultimately, it is the role of the management team to know their target market and relevant sector inside out.
The investor may challenge the management team and hold it accountable for its decisions and actions, but they are not the driving force of the business. Therefore, sector experience is not a necessity.
Given that the route to exit could be between five and 10 years, however, the startup’s proposition should be compelling and enduring for the investor.
This could stem from the impressive capabilities, passion and dynamism of the management team. Perhaps there is also a killer business model that looks guaranteed to succeed.
Other factors, widely considered part of the ‘5Ms of startup investment’, include momentum (is the startup speeding beyond its growth targets?) and market (is it absolutely ripe for a new approach to take over and dominate?). Less exciting, but equally important, is money. Is there enough to realise the plan?
Alongside all of these, there should also be a genuine interest in the startup’s plans and what it is aiming to achieve.
And this may partly come from an affinity between the investor’s own sector experience and the startup’s area of focus. The promise of seeing how the business manages to shake up a sector they know well could help to retain their interest over the several years it may take for the investment to be realised.
But it is also important to note that many angel investors choose to back multiple startups. This enables them to diversify their portfolio, increase their chances of a surging success that delivers mammoth returns and offset the riskiness of enterprise investment.
While some may represent sectors the investor knows well, many may not. By having a good grasp of the universal factors that dictate startup success, they can venture into industries beyond their realm of understanding.
This enables them to build a well balanced and healthy portfolio, while learning new things along the way - and as a startup investor, you must decide whether to stick to what you know – perhaps as a starting point – or dive straight into another sector you are eager to explore.