Venture capital (VC) investing can be a volatile field, especially for those who specialize in startups and early-stage investments.
That said, unlike passive investments in stocks or funds, venture capital investors can take a much more active role in the performance of the startups and companies they choose to partner with.
Why is Risk Mitigation Important?
The right combination of proactive support and risk mitigation can increase the likelihood of a startup’s success — and a successful exit from a given investment.
With these five risk mitigation tactics, you can rest easier knowing that your portfolio is as protected as possible.
1. Due Diligence
Anyone who enters the venture capital world without committing to a robust due diligence process isn’t going to be investing for very long.
Due diligence is a process that every VC goes through before investing in a startup. Standard considerations include analysis of the market opportunities, management team, business model, operations workflow, technology and more.
Also, due diligence doesn’t stop once the capital changes hands. Certain forms of transparency can be baked into the agreement to keep an eye on how the investment (and the startup) is performing. These can include everything from access to accounting metrics to regular compliance audits and stakeholder meetings.
What do farmers and venture capitalists have in common?
Neither should have all of their eggs in one basket.
Diversifying your VC investments is one of the most effective ways to mitigate risk, especially over the long term. Many VCs, for example, commit to a three- to five-year investment timeline with a given startup. This approach provides more stability in that contracts don’t all start and end at the same time. It also helps investors keep track of longer-term performance and take steps to correct any problems that might arise (see #5 below).
This principle also applies to the types of businesses you invest in, or sector diversification, as well as fund diversification, in which a VC chooses to work with early-stage or late-stage startups or a mixture of both.
3. Reduce Variables
Even if the results of the due diligence process are sound, there are a lot of factors that can contribute to a startup’s success or failure.
Further, many of those factors — market fit, competitor performance, vendor availability, advertising effectiveness, etc. — are out of the startup and investor’s control.
Reducing the variables in your investment is another way to mitigate risk. In practice, this might include doubling down on a winning advertising channel, choosing the right niche, or hiring trusted staff that you’ve worked with before. Every question mark that you can turn into a sure thing will boost the chances of your investment’s overall success.
4. Contract Structure
Many institutional investors see venture capital for startups as a risky investment It’s also a well-known fact that even the best ideas don’t always turn into successful companies.
That’s why many VCs include contract language that ensures they’ll get their money back first if a startup goes under or has to be sold under less-than-ideal circumstances. With this structure in place, VCs can protect against failure while still doing all they can to help their startups succeed
5. Hands-On Assistance
Our fifth and final resource for risk mitigation is closer to you than you might think.
In fact, it’s the person you see the mirror.
Most VCs and investors become investors because they’ve succeeded in some form of business or another. That specialized knowledge grows as you work with startups, consider new investments, and track performance over time.
Sharing those lessons with the startups you work with is a great way to chart a more lucrative path, course-correct if necessary, and increase the probability of a healthy ROI.