Start-ups are typically founded by one or more entrepreneurs with the aim to develop a product or service for which they deem there is a demand. Many start-ups begin life with high costs and limited revenue, which is why they seek capital from a variety of sources such as venture capitalists.
How a start-up works
Start-ups generally focus on a sole product or service that their founders want to bring to the market. These types of companies generally lack a fully developed business model and the capital needed to fund the growth of the businesses. They are usually funded by the founders, family members and friends or in some instances capital is raised through venture capitalist investment.
The legal structure of a start-up can vary depending on the type of structure that best suits the entity. If the founder of the start-up is also the key employee of the business then they may choose to set the company up as a sole proprietorship. If there are founding partners who have joint ownership then setting up a partnership may be the best structure.
If founders want to reduce their personal liability, then they can register the company as a limited liability company. Registering a start-up as a limited liability company can help safeguard the founders and ensure that they are not personally pursued for the repayment of the company’s debts or liabilities.
A start-up can have physical premises or be an entirely online business, and the location of the business will depend on the product or service it offers. Getting the location of the business right and deciding whether physical premises are needed can help give the start-up the best possible start and could save costs if it is deemed a physical premise is not needed.
The vast majority of start-ups fail within the first year or two, which can make them a risky investment. The main reasons start-ups fail include entering an already competitive market or lack of funding to develop and grow the business.
Advantages of start-ups
The advantages of start-ups include:
Diversify your portfolio
When it comes to investing in start-ups, one of the biggest advantages is their ability to diversify your portfolio. As the majority of start-ups are not affected by macro-level market shifts, they can be a good way for investors to detach themselves from market trends.
Potential for high returns
Firstly, stocks in start-ups tend to be priced lower than those of established, less risky investments. This means investors can purchase a greater number of stocks which if the price goes up could yield a good return. Secondly, while the company may be a start-up now it could be the next big thing in 5 years. Investing early could have the potential for high returns in the long term.
Disadvantages of start-ups
The disadvantages of start-ups include:
Can be high risk
Financially backing any company that is in its infancy can be high risk and this is true of start-ups. With a large percentage of start-ups failing within the first few years, some investors are wary of them and avoid them, whereas others see them as a possible opportunity to get on board with something big early on.
May take a long time to achieve gains
Early investment in a start-up will unlikely achieve short term gains, in fact, it often takes a considerable time for investors to achieve gains. This is fine if they are seeking long-term investment opportunities, but those looking to make quick returns may want to consider other investment instruments.