Mitigating Risks in Startup Investments: Best Practices and Proactive Strategies

As a result of previous years' policies involving low interest rates and quantitative easing, numerous institutional investors and lenders frequently provided funding to many startup companies without conducting thorough Know Your Customer (KYC) procedures or pre-vetting processes. In many instances, these startups lacked a sustainable and self-sufficient business model. 

Typically, such startup companies are still in the early stages of the business cycle, where they are validating market needs and competing for market share. Consequently, they do not possess a viable self-sustainable model that can generate enough profits and cashflow to sustain their operations or support expansion. In light of this, they heavily rely on investors’ funds or creditor’s loans to survive and continue growing. 

Under favourable circumstances, startup investors or creditors have the potential to exit their investments by selling their stake, merging the business with a larger company, or by taking the startup public through a stock market listing. However, in recent years, the pandemic,  global economic downturn, and increasing interest rates have created difficulties for startups to sustain without new injections of funds. As a result, these startups face the prospect of lower valuations and investors are often forced to sell their shares under unfavourable terms and at significantly reduced valuations. In some cases, these startups may even face bankruptcy.

Lessons learned and proactive measures to be taken

Institutional lenders and investors should conduct thorough due diligence before making investment or lending decisions. FTI Consulting offers a team of experts across various sectors who can perform not only standard financial due diligence but also comprehensive operational and technical due diligence for specialised sectors.  

For institutional lenders, several mitigative measures can be implemented during the financing terms: 

• Prior to providing financing – engage an independent professional advisory firm for pre-lending advisory services. This includes conducting an investigation into the target company's underlying business to assess its creditworthiness, as well as performing a high-level valuation of the pledged securities or collaterals. Pre-lending advisory services provide lenders with a clearer understanding of the target company's business model and potential credit risks, enabling them to adjust financing terms to minimise risks more effectively.
• During the lending period – conduct regular reviews of the target company's business affairs and performance. Additionally, schedule periodic meetings with management to gain insights into their business plans and forecasts.
• When red flags emerge – such as non-performing ratios or default payments, seek professional advice and support to address the situation promptly and effectively. This may involve engaging consultants or experts with experience in turnaround management or financial restructuring.

By implementing these measures, institutional lenders and investors can enhance their risk management practices, make more informed decisions, and mitigate potential losses associated with startup investments or lending activities.

The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, Inc., its management, its subsidiaries, its affiliates, or its other professionals

FTI Consulting, Inc., including its subsidiaries and affiliates, is a consulting firm and is not a certified public accounting firm or a law firm.