Is investing in a tech startup right for you?

These days, when someone mentions innovation, progress or inventions, they’re usually talking about the world of technology. And what makes technology investing so appealing is that anyone can get involved, not just the extremely wealthy and influential. There are various opportunities available, both big and small, and securing one is relatively simple. The main consideration is whether the risk is justified by the reward.

Investing in a technological startup

The tech industry’s vibrant startup culture is one of its many strengths. Technology startups represent significant growth opportunities for forward-thinking investors.

The size of technology startups varies considerably, from just-launched private companies to newly listed public companies. As the “startup” name implies, these are small-scale businesses that are typically in the development or early implementation stages and are looking for funding from venture capitalists and angel investors to commercialise their products.

Thanks to the help of clever investors, a number of innovative technology startups have evolved into some of the world’s most recognisable technology companies, including Facebook, Twitter, Airbnb, Snap, Snowflake, and DoorDash.

While the tech sector is extremely volatile, and investing in startups can be risky, early-stage investing can be financially rewarding if you pick the right company.

For example, someone who invested US$10,013 in 589 shares of Snap — Snapchat’s parent company — during the company’s March 2017 initial public offering (IPO), would have paid US$17 per share. By March 2021, that investment would have been worth an impressive US$36,924 — representing a 38.5% compound annual growth rate.

There are numerous tech startups to choose from in every sector of the technology market, making it difficult to determine which businesses are worth the risk. In this article, we’ll explain how to invest in technology startups and why it might be a good fit for you.

What to look for when selecting a tech startup

The harsh reality of venture capital investment in any industry is that 90% of startups fail within a decade. However, investors can mitigate this inherent risk by conducting thorough due diligence. Investors should look for companies that have a strong sense of identity, the potential to dominate a specific market niche, and a strong management team, among other things.

Due to the rapid pace of change in the technology industry, it is critical for businesses to articulate a clear vision of who they are, who they want to support, and who they intend to target as competitors. Technology is a tightly knit ecosystem, with numerous companies collaborating to create incredible end products. Without a clearly defined identity, businesses risk causing disruption — and not in a positive way.

However, tech startups require more than a strong sense of identity. They also need to have a bold vision of the impact they want to have on their target market. This potential for market leadership is critical to consider when investing in technology startups. The first and best company in a particular niche enjoys a clear competitive advantage, making it an attractive investment opportunity.

Businesses with an innovative value proposition that addresses a new market segment or an unmet need within an existing sector, have the potential to become future market leaders.

Investors should also conduct due diligence on the management team. Is the team distinguished by a breadth and depth of expertise that gives the company a competitive edge in the sector it’s pursuing? Look for management teams that comprise individuals with a track record of building successful businesses and who could apply models they’ve successfully used before within their current company. Additionally, a well-rounded team will include professionals in finance, marketing, and operations.

Grow your industry knowledge

To determine whether a startup is truly filling a valuable yet under-served niche in the sector, investors should first aim to understand the technology market.

The technology sector is focused on electronics manufacturing, mobile app development, software development, computer hardware, and products and services relating to information technology. It includes business-to-consumer (B2C) goods such as personal computers, mobile devices, wearable technology, home appliances, and TVs. Additionally, it covers business-to-business (B2B) products and services such as enterprise software, logistics system management, and the collection, protection, and analysis of critical data.

All of these B2C and B2B goods and services are important to the global economy, which explains why the technology sector is one of the most attractive investment .

Social media, blockchain, cloud computing, fintech, mobile apps, the internet of things (IoT), artificial intelligence (AI), medical devices, gaming, and cybersecurity have been the leading growth segments for the technology industry in recent years.

In the coming years, the cloud-based everything-as-a-service segment of the market is expected to perform particularly well. According to Deloitte’s 2021 outlook report, “global as-a-service revenue will reach US$355 billion over the next few years, fuelled by emerging business models such as content-as-a-service, artificial intelligence-as-a-service, and Internet of Things-as-a-service.”

Meanwhile, revenues in the technology industry’s AI segment are expected to reach US$100 billion by 2025, “driven by machine learning, deep learning, and conversational AI applications. Healthcare, remote work, and education may see some of the highest levels of AI adoption.”

Another multibillion-dollar market is financial technology. According to Research and Markets, this segment of the technology market will be worth approximately US$305 billion by 2025.

Additionally, autonomous vehicles, natural language processing, bioinformatics, and 3D printing are among the top emerging technologies to monitor in the near future, according to Lux Research’s Foresight 2021 report.

Why should you invest in a technology startup?

Large private equity firms and savvy investors seize the opportunity to invest in a technology startup for the following reasons;

Great ROI

Investors can sell their shares at an exponential rate of return once the technology company goes public. For example, venture capitalists can anticipate a modest 10x return on investment within 4-5 years.

Additionally, investors accrue passive income over time via dividends. Most investors can live with a modest expectation of over 15x ROI growth.

Avoid volatile stock prices

Events such as the COVID-19 pandemic could have a significant impact on the economy, driving down the stock prices of publicly traded companies.

Due to the fact that technology investments are not yet publicly traded, they are less likely to be impacted by societal events that cause market fluctuations.

For example, while the stock market suffered a general decline as a result of the coronavirus outbreak, technology startups such as Netflix and Amazon continued to grow at a rapid pace.

Capitalisation

To launch a technology startup, small amounts of money are typically required. Therefore investing in them early on can result in significant future profits should they succeed. Compared to investing in large technology companies alongside hundreds of other investors, being one of a few shareholders in a startup for the same amount of money is a much better deal. 

Diversifying your holdings

If you’re a seasoned investor, you’re already aware of what this means. It’s beneficial to have a diverse portfolio that includes both large corporations and startups. This method will assist you in balancing the risks and rewards associated with all transactions.

Rapid growth

By and large, technology startups are extremely progressive and innovative. They take advantage of technology and trends, which enable them to grow and adapt quickly to changing conditions. If everything goes according to plan, your investments can yield significant returns relatively quickly.

Tax reduction

Certain governments actively support early-stage investors by offering tax breaks, rebates, and deductions. The Australian government is offering 45% cost rebates for apps that aim to improve our economy. Investing in these kinds of apps can be described as a mutually beneficial arrangement with the state, as the technology sector contributes to economic growth, and you earn profits from your startup investment and pay lower taxes as a result.

A track record of success

When it comes to stock market growth, tech startups have a track record of success. Within the last decade, technology stocks have seen an average annual dividend growth of about 25%.

Having said that, it is necessary to recognise that financial risks are inherent in investment practices.

Pre-IPO investing, in particular, exposes investors to the risk of losing money if the company is valued too low when it goes public. According to Goldman Sachs, only 24% of initial public offerings were profitable in their first year of trading in 2019.

Additionally, private companies and startups may postpone going public due to corporate governance concerns or stock market apprehension.

Wrapping up

Investing in technology startups has the potential to be highly financially lucrative.

And while investing in technology startups involves some risk (as, indeed, does investing in the stock market) the demonstrated benefits often outweigh the potential costs.

Follow our tips and consider your options carefully to identify the best technology startup to invest in, but remember that getting involved in the industry that dominates the business world could be a fruitful and potentially life-changing financial move.