Why most startups are high-risk investments

Startup equity is a high-risk claim for reasons that can be listed without a slogan about failure. The company is young. The stake is hard to sell. Later investors may rank ahead. The only way many shareholders are paid is if the company is sold or listed. Each of those can fail while the founder is still working.

A business that survives is not a return

Official statistics sometimes get recruited for this conversation and then misread. The US Bureau of Labor Statistics publishes how many new establishments are still operating a year after they are born, and those rates vary by year and by place. An establishment is a place of business. It is not a venture-backed company, and ‘still operating’ is not ‘returned cash to a shareholder’. A shop that is open and a share that cannot be sold are different facts. Using a survival table as if it were a startup investor’s win rate mixes the two.

What the risk actually is

• Loss of the amount invested. The FCA states that many startups fail and that investment-based crowdfunding may result in a total loss, with no UK compensation scheme behind it.
• Illiquidity. The SEC states that securities bought under Regulation Crowdfunding generally cannot be resold for one year, and a year is the legal minimum, not a promise of a buyer afterwards.
• Dilution and rank. Later money can shrink a stake or stand in front of it if the terms say so.
• Information. The investor often knows less than the founders, and less than a fund that sits on the board.
• Time. A fund can wait. A household that needs the money for a dated bill cannot use the same patience.

A reading: ‘high risk’ here means the distribution of outcomes is wide, and one of the likely outcomes is zero. It does not mean every young company fails, and it does not mean a particular company on a platform has been assessed. The category is risky because of the structure of the claim.