The five risks in every direct deal, and how families reduce them
Built on Chapter 11 of The Single Family Office by Richard C. Wilson. Full chapter text: FamilyOffices.com.
Direct investing carries real risk. If it did not, every investor would put all their money there and skip diligence. Many young companies fail, many break even, and only some turn a profit. The families who do well name the risks up front and build protection into each deal. These are the five I look for every time.
1. Technology risk
Many companies depend on a product working as promised. In tech companies, success can ride on a few engineers or on whether the market accepts a new tool.
The best protection I know is to invest in stages. Put in a first tranche up front. Release the next one when there is a working prototype, another at a first revenue target, and another at a larger one. The founder gets clear goals, and the family is not exposed all at once if the product never works.
2. Market risk
A product can work and still fail because customers are not ready. Plenty of companies spent heavily on marketing years before buyers were willing to change habits.
To reduce this, invest in markets your family understands. Check demand with real customers and competitors before you commit. Look at whether the management team has sold to this market before. A mentor of mine liked to say that a company should prove the market fast, and the burden of proof belongs to the company raising money.
3. Competitive risk
Even a good product can be crowded out. A large player with better distribution may copy it, or a wave of copycats may drive margins down.
Barriers help. Brands and patents make life harder for rivals. So does thought leadership, such as a book, a newsletter, or a respected voice in the industry. Some marketers test a product in a small niche, then lock up the obvious names and channels before they launch widely. When rivals see a market already well defended, many look elsewhere.
4. Management risk
This is the biggest risk in young companies. The person who writes great code or makes a great product is often not the person who should run a growing company. The founder has to grow faster than the business, or step aside.
Check whether the founder is coachable. Ask whether they would accept a board seat or a different role later. Personal guarantees, performance clauses tied to revenue, and board seats or voting rights for the family all help. A strong operating executive next to a visionary founder can make a big difference.
5. Finance risk
Success creates its own problem. A company that sells well often needs more money for inventory, new markets, or wider distribution. Terms set by early investors can scare off the next round.
Think ahead to that moment when you negotiate. Avoid unusual terms that later investors will reject. Ask whether you really need other investors to lose for you to win. A deal that works for every round is usually better for the family in the end.
Results come in a wide spread
Even careful investors see uneven results. Some deals are big winners, some return a modest gain, and many lose money or are quietly closed. One serial launcher of consumer products I have spoken with described the same spread from decades of experience.
That is why diversification across several direct deals matters, and why no single deal should be large enough to hurt the family badly.
Put it in a risk memo
Before closing, I like a one-page memo that names each of the five risks for that deal and the protection in place. If a risk has no protection, the team should decide on purpose to accept it, in writing. Reviewing these memos later shows the family which risks it handles well and which ones keep catching it out.
What to take from this
- Release money in stages tied to clear milestones.
- Test demand with real customers before committing.
- Build barriers such as brands and patents before rivals notice the opportunity.
- Write a short risk memo for every deal before closing.
This page is general information, not legal or investment advice. Speak with a qualified attorney and advisor before structuring any direct investment.
Questions and answers
What are the main risks in direct investing? Five kinds: technology and market risk, plus competitive and management risk. Finance risk rounds out the list.
Which risk is biggest for young companies? In my experience, management risk.
How can a family limit technology risk? Invest in stages and release money as milestones are hit.
Why plan for future rounds? Growing companies usually need more money, and bad early terms can block it.