By Anne Sampson

There are few sensations investors relish more than putting funds into a startup that snowballs. Not only can it be a validation of your business acumen and hugely financially rewarding, on top of this you’re part of a catalyst to the economy – startups create wealth, jobs and activity. But, as anyone who has cast their net out will tell you, investing in startups is no fool’s game. Myriad factors are at work in the startup game, and success is largely dependent on them aligning your way.

One of the attractions of startups for investors are the potentially remarkable risk reward ratios on offer: the most lucrative startups can yield staggering returns of between 5 and 100 times the initial investment. Yet there are countless investors out there with tales of getting sucked by inflated or over ambitious projections and burnt as a consequence. So, what can you do to optimise your chances of investing in a sustainable and profitable startup? Start with our tips to give you the best chance of picking a winner:

1.   Develop a robust risk management strategy & diversify your investments

This is a fundamental when investing in startups and it is simply essential you get it right. A robust risk management strategy is one with perspective, one in which the risk you assume reflects your liquidity and strength. When you’re winning, increase risk. When you’re losing, reduce risk. Diversification is a time tested and key element of your risk management strategy. It increases your chances of success and mitigates your risk. Diversification also significantly improves the likelihood that you’ll get your money back by way of returns as a liquidity event – for example the startup being acquired or a public offering.

2.   Stay close to home by investing in an industry you know

It goes without saying, the greater your knowledge of the market and industry in which the startup operates, the greater your capacity to reduce and manage the risks you’re undertaking. Your perspective will make you more perceptive of potential threats and weaknesses, and better able to anticipate industry or legislative change. All this will help towards accurately evaluating the startup’s projections, long-term scalability, and ability to succeed on a sustainable and independent basis.

3.   Dig deep into their monetization strategy and financials

They might possess an admirable company ethos, a social purpose, and core values you could buy into every day of the week, but without a solid, achievable and sustainable bottom line, the only option is to pass.  The bottom line has to be growing. Or at least with potential to, vastly. Does the startup charge a competitive and attractive rate for its services? Can this rate sustain and ultimately fuel the growth of the business? How have they arrived at their price points and what depth of analysis has gone into their projections? These are the questions you must be asking as you work through their financials. They should be able to justify every last cent of their burn rate. And as a startup, they must demonstrate the dynamism necessary to adapt when they – almost inevitably – don’t hit their initial projections.

4.   Do plenty of research on the founders

Quite possibly the most vital factor in the success or otherwise of the startup will be the founders. So check out their histories in as much details as is viable. What have they achieved in their careers so far? Where have they worked, where did they study? Trust your instincts, but also do your research, and try to get a sense of how they would perform under stress and even strain.

5.   Broaden your options for deals with an equity crowdfunding platform

Equity crowdfunding has grown exponentially over the last decade or so – use this to your advantage. The deal flows on equity crowdfunding platforms can be rapid, sometimes overwhelmingly so, and you will soon have investment options piling up left, right and center.  The large numbers of startups has increased competition and, in some cases, led to an environment favoring investors. Be sure to carry out your due diligence on the market conditions and competitive landscape in which the startup operates. This is doubly true if you’re new to investments or the industry. And of course, never invest money you cannot afford to lose.

Anne Sampson is a former eLearning consultant that crossed paths with trading, and quickly became really passionate about it. Other than exploring the financial market and writing about it, she is constantly engaged on providing support for a couple of awesome online courses! @anne_samps

Startups stock photo by Song_about_summer/Shutterstock