Question & Answer
How Do I Reduce My Investment Risk?
Risk is the shadow that follows every investment. It lurks in market fluctuations, in the balance sheets of companies, in the unpredictability of founders, and in economic downturns that no one sees coming. But for those who understand how to structure deals properly, risk isn’t something to be feared—it’s something to be managed, mitigated, and sometimes even turned into an advantage.
So, how do you reduce your investment risk? The short answer: through intelligent structuring, asymmetric deal-making, and using protective mechanisms. The long answer? Let’s dive in.
Control the Downside, Capture the Upside
Every investor wants to limit their losses while maximising returns. This is why structuring a deal correctly is more important than merely finding a “good” investment. There are several ways to ensure downside protection:
- Liquidation Preferences: If you’re investing in equity, ensure that your shares come with a liquidation preference, ideally a multiple. This means that in the event of a sale or liquidation, you get your money back (or more) before common shareholders see a penny.
- Revenue Share Agreements: Instead of waiting years for an exit, structure deals where you receive a percentage of revenue as long as you’re a shareholder. This way, you’re not solely dependent on an eventual buyout.
- Mezzanine Financing: A hybrid between debt and equity, mezzanine financing gives you priority over common shareholders while still allowing for equity-style upside.
Use Earnouts to Reduce Risk
What if the company you’re investing in isn’t as great as the founder claims? What if revenue projections are more fiction than reality? Enter earnouts.
Earnouts allow you to structure your investment so that a portion of your capital is only paid out if certain milestones are met. If the company performs well, the seller or founder gets their full payout. If not? You just saved yourself a financial headache.
For example, if you’re acquiring a company and there’s uncertainty about its future growth, you could structure the deal as:
- 80% of the purchase price paid upfront.
- 20% held as an earnout, only payable if revenue increases by 15% within 24 months.
Now, instead of taking a leap of faith, you’ve aligned incentives and reduced risk.
Guarantor Deals: Risk Without Capital
What if you could invest without putting down cash? Guarantor deals allow you to leverage your financial standing instead of injecting capital. Instead of writing a cheque, you put your name on the line as a guarantor for a loan—and in return, you receive equity.
This is particularly useful for investors who have a strong financial position but want to minimise cash outflow. The key, however, is to structure an expiration mechanism. For example:
- Ensure the company is required to release you from the guarantee after 36 months.
- Include a clause allowing you to force the company to repay the loan if they don’t remove you from the guarantee.
Prioritised Payments & Debt Structuring
If you’re investing via debt, ensure your repayments come before any dividend payouts or high executive salaries. A prioritised payment structure ensures that:
- Your loan is the first to be repaid from any incoming cash flows.
- The company cannot distribute profits to founders or shareholders until your debt is cleared.
This structure significantly reduces the risk of default.
Use Options to Hedge Uncertainty
Instead of committing capital upfront, consider using options in your deal structuring. Options give you the right (but not the obligation) to buy additional shares at a pre-agreed price in the future. This is particularly useful in high-risk investments where the future is uncertain.
For example, if you invest at a valuation of $5 million, you could negotiate an option to purchase additional shares at the same valuation within the next two years. If the company grows to $15 million, you just secured additional shares at a bargain price.
Final Thoughts
Reducing investment risk isn’t about avoiding risk altogether—it’s about structuring your deals in a way that shifts risk away from you while still allowing for upside. Whether it’s through liquidation preferences, revenue-sharing, debt prioritisation, or earnouts, there are multiple ways to ensure that when things go wrong, you’re not the one left holding the bag.
Want to learn more about structuring deals to minimise risk? My book covers these strategies in depth. Check it out here.
Deal Structuring
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In this book, you will:
- Be introduced to the fundamentals of deal structuring
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