By Omoruyi Edoigiawerie, Esq
Generally speaking, start-ups possess the healthy potential to pursue, develop and validate scalable businesses. Nigeria is reputed to have the largest start-up ecosystem in Africa and with the enactment of the Start-up Act, it is now poised to lead the ecosystem in the region and also compete from a place of advantage at the global level.

With the above in mind, investing in Nigerian start-ups would not be out of place especially when they demonstrate potential, the ability to stand out in the market, and yield a meaningful profit; thereby providing a healthy return on investment for an investor.

These advantages should however not becloud the proneness of the risk and the overwhelming volatility that often characterise investments in start-ups.

Investing in a start-up from its budding stage is often most advantageous and more beneficial for an investor as it often yields more profit and shares stake in the start-up.

However, investing early in a start-up not only confirms higher returns but also puts the investor in the front seat of the volatility that may befall the company and this makes it imperative for investors to dispassionately weigh their options before investing in a start-up.

The focus of this week’s article is to highlight salient considerations which investors must reflect upon before investing in a start-up.

I hate borrowing, don’t want to leave huge debt for my successor – Umahi

*Important considerations

1. Investment starts with proper research– not just on the business but also the founders: The starting point of any investment is detailed research on the business and even more importantly, its founder(s). Due diligence is the most important aspect of investing in a start-up. Oftentimes investors want to be sure the business idea checks all the boxes and they forget to apply the same scrutiny to the founders of the business. Investors must realize that the founders behind a company are the most critical factors affecting the potential success or failure of the business and not the business idea, market, or profitability. The key to any successful business is the person in the front seat driving the operations. So it is advisable to run background checks, do due diligence, verify their track record, ask questions and get referrals. It may also be important to check their social media interactions and commentary if need be; these are the things that will help to understand the character of the people you are giving your funds to.

Correspondingly, another very important consideration is whether or not the founders are willing to “put their money where their mouth is” while most investors want and appreciate passionate entrepreneurs, they should also examine to see if these entrepreneurs are willing to invest their own money in the business.

2. Understand the start-up’s fiscal history: Many investors preoccupy themselves with business plans and business models and gloss over the financial history, fiscal responsibility, and lifestyle of the start-up before their investment. The fiscal history of a start-up, the lifestyle of its founders, and the financial plan for the future must be considered conjunctively. It is important to understand the ‘what’, ‘why’, and ‘how’ the start-up is intending to spend money. So it is important to dig deep into their spending to date, as well as their plans. An easy pointer is to review the companies’ salaries and see how much the founder(s) pay or intend to pay themselves. Additionally, a critical examination of the ability of the invested funds to actualize the intended milestones is very important.

Gov Wike invites Buhari, Obi, Oshiomhole, others to inaugurate projects in Rivers

3. Understand the market: I have always maintained that investments are emotional decisions that only rely on paperwork to validate the feelings or disabuse the minds of the investor. When an investor like the idea put forward and is happy to invest, they do not do detailed market research to benchmark the business idea with. This is a significant error; chances are that there are similar businesses out there. Now while the presence of a similar business should not foreclose the intended objective, it is very important to understand the competition that the business has surrounding it and what the market is like. This will help to understand if they have a competitive advantage, their unique selling point or if they need to do more work. Many new ideas are so cutting-edge that they risk not gaining market adoption. Legal, regulatory, and compliance issues are also important to consider for brand-new ideas. I always advise clients looking to invest in start-ups to do some independent research about how the business would perform in the currently existing market. This will help them understand the current customer demands and expectations and then nudge the founders to develop their product based on the existing feedback.

4. Diversification is indispensable: Smart investors do not put all their eggs in one basket. This is one of the most pivotal rules of investment. Investors must be guided not by the profitability of their investments but by the potential risks, and the steps to take when there is a failure in expectation. Wise investors do not blindly spray and pray across every pitch they see and like. So, the prudent decision is to put a peg on your investment and diversify across different industries and markets.

By putting their capital into a more selective range of start-ups, investors have a far more positive impact and mitigate risk.

5. A clearly defined exit strategy: Oftentimes investors fixate heavily on the investment and the expected returns that they do not properly contextualize the end goal of their investment and the exit strategy. It is important that right for the onset investors have a firm grasp of the relevant timelines and can adequately project the next level of their investment or their exit strategy. This is very important. A defined exit strategy is pivotal for any viable investment.

*Conclusion

Investing in start-up companies can be a very risky business, but also it can be very rewarding if and when the investments do pay off. As risky as it may seem, investing in start-ups is the pivotal building block that founders of start-ups need to scale their businesses and bring them to life.

Investors should also realise that start-ups are dependent on their investments and they will blossom efficiently when the founders and the investor(s) have a healthy and participative relationship centred on a common understanding fuelled by proper research, full disclosure, and the right mind-set.

Omoruyi Edoigiawerie is the Founder and Lead Partner at Edoigiawerie & Company LP, a full-service law firm offering bespoke legal services with a focus on start-ups, established businesses, and upscale private clients in Nigeria. The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. His firm can be reached by email at hello@uyilaw.com