If you aren’t willing to take some risk as an entrepreneur, then don’t expect any gain. Yet everyone has limits, and every investor implicitly has similar limits on what makes a startup investable, or one to avoid at all costs. If you need investors, it’s important that you understand their filters, and even if you are funding your own efforts, you need to recognize the red flags.
Of course, every risk level can be mitigated by a good plan that addresses the issue, offers a credible action plan, and will convince you, as well as investors and customers, that what looks like a risk to many is actually a sustainable competitive advantage for your startup.
Nevertheless, we can all benefit by understanding a collective view from investors on the high-risk elements that every new business has faced historically based on the team, as well as in the marketplace. Here is my perspective on the highest risk elements, from my years of working with investors and watching startups come and go:
1. All the co-founders are first-time entrepreneurs.
A strong team has one or more executives who have run a startup before in the current business domain. Even top big-company executives are considered high-risk in a startup environment. The challenges are as different for them as a jewelry store owner now building medical devices.
2. Your startup is in a high-failure-rate business sector.
These historically have included work-at-home, restaurants, telemarketing and social-service providers. On the Internet, I am wary of one more search engine provider, clones of existing social-media sites, and yet another new dating site. You need a big differentiator in these arenas.
3. Products requiring changes to government regulations.
Things such as driver-less cars and new medicines are far more than a technology challenge. They require exhaustive and money-consuming tests and trial periods, followed by bureaucratic approval cycles that can take forever. If you have deep pockets, these ultimately can be very lucrative.
4. Huge ramp-up time and money required.
For new car companies such as DeLorean and Tesla, designing and testing the product is only the beginning. Huge investments are also required to ramp up manufacturing, build a distribution network, and provide the support infrastructure. New drugs usually fall in this category, due to side-effect testing.
5. Niche or low growth-rate businesses opportunities.
Investors are looking for large opportunities (greater than a billion dollars) with double-digit growth rates. Others may indeed make good family businesses, but are usually deemed worth investment. These are ones you need to bootstrap, crowdfund or pitch to friends and family.
6. Marginal legality or public image.
Don’t expect investors to line up for your new online gaming site, adult entertainment or quick sources of cash. Professional investors put great value in their integrity, so they won’t risk it by making investments that some people would view as in poor taste. These may traditionally have high returns, but are still high risk.
7. Off-shore or foreign-country based.
Every country has their own unique business requirements and customer culture. Thus investors in one country do not assume that they know what works in another country, even if it sounds good locally. If you want U.S. investors, for example, it may be worthwhile to set up an office in New York City or Silicon Valley.
No entrepreneur should consider any of these challenges as hard barriers, but they do need to be aware of higher risk perception, and include their mitigation strategy in their business plan for all to see. I encourage you to be proactive on these issues, rather than saying nothing unless questioned. Responding to a challenge will always make you look defensive, and many people will walk away without asking.
It’s also not smart to switch from a domain you know and love to a perceived lower-risk business that you know less about, or have no passion for, just because it may be more attractive to investors. Passion and commitment can overcome many risks, and these will also drive you to expand your scope of options for funding and implementation, leading to success.
If you are a true entrepreneur, you will find that a reasonable level of risk is necessary to incent you to go beyond the status quo of an existing problem. But in all cases, it pays to keep your eyes wide open, and do your homework on the pitfalls that others before you have faced. Only then can you enjoy the journey, as well as reach the destination.