How to Invest in Startups: What You Need to Know
When investing, not many people think to invest in startups. The companies are new, unproven and come with great risk. But wise investors are always looking for new opportunities. And sometimes those opportunities aren’t on the stock market.
Early investors can see big gains with startups. For example, early Snapchat investors turned $100 into $22,000 when Snapchat went public. That’s a 21,900% gain.
If you’re wondering how to invest in startups, the details are below. Let’s take a look…
What is a Startup?
In order to invest in startups, you need to understand what a startup company is. But this can be difficult. There isn’t a clear definition.
However, there are a few ways to identify a startup. The first is the company will usually be in early stages of development. And, founders typically start the business to focus on meeting a specific market demand. This could be a product, service or platform.
Often founders invest their own money into the business. But about two-thirds of startups seek outside investment or take out a loan.
Another trait of a startup is the company wants to grow. That’s usually the difference between a small business and a startup. Ian Wright, founder of Merchant Machine, says:
“All startups by their very nature will start out being small businesses, but not all small business are startups. The difference with startups is that it’s their goal to no longer be a startup at some point in the future, while many small business owners are more than happy for their small businesses to remain small businesses.”
And finally, startups are filled with passion and questions. Often, founders of a company work long hours, usually with minimal to no pay. But they continue to work on the company, hoping it will one day take off. They just don’t know when, or if, that will happen.
However, if it does happen, investors could be there to profit. An investor might have ten investments that all fail except one. And that one startup could make it all worth it.
Before we start looking at how to invest in startups, there’s one more thing to know.
Best Practices for Startup Investing
Investing in startups is a risky game. There is no guarantee of success and profit. However, there are steps you can take to help decrease the risk.
Invest in what you understand. If you know nothing about biotechnology, it’ll be difficult to ensure that biotech startup is legit. Make you know the product, the market and the company’s goals. If you have expert knowledge in an area, it may be beneficial to find a related startup. Not only can you invest, you might be able to share your knowledge.
Look at the documents. Make sure the company is real. Look for documentation that the company is legally setup, shares are issued properly, and leases and contracts are ratified. Looking for pre-vetted startups can help make this step easier.
Look at the numbers. There are a lot of unknowns with startups. There is no certain value. It’s usually a guess. So, look at how much your share in the company is worth. Ask the company how much it’s already raised. If some funds came from customers, it’s often a good sign.
Reserve capital. Don’t invest everything right away. Consider investing a portion of capital in the first round. If the company is able to move forward and continues to grow, you can invest more. But if the company fails, you minimized your losses.
Know the risks. Startups come and go. Some succeed and some don’t. Investors should be prepared to not see a return for up to 10 years. And in some cases, investors will never see a return. So, be prepared to lose some money.
Practice diversification. Investors might invest in more than one startup. This increases the chance of finding a successful startup with high returns. However, it can be more difficult if all startups in a portfolio are in the same industry. Consider investing in startups with difference markets, such as technology, retail or marijuana.
With these practices in mind, you probably want to know…
How to Invest in Startups
Investing in startups or pre-IPO companies isn’t easy. But thanks to the SEC’s crowdfunding regulations in 2016, it’s easier than ever before. So here are a few ways on how to invest in startups.
- Find a crowdfunding site. This could be SeedInvest, Kickstarter or GoFundMe. Crowdfunding sites are one of the most popular ways to invest in startups.
- Be an angel investor. Angel investors are people who invest in startups, usually with a one-time investment.
- Make business connections. You never know when your coworker or neighbor could decide to become an entrepreneur.
- Monitor the news. Startups can be found when its product meets a big demand. One example is Everlywell, a startup looking to make lab testing accessible to anyone.
- Talk to your local bank. Startup companies might seek loans for funding.
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Angel investor Paul Graham is one of the most recognized individuals in the startup industry. He says:
“I put it off because it seemed mysterious and complicated. It turns out to be easier than I expected, and also more interesting. The part I thought was hard, the mechanics of investing, really isn’t. You give a startup money and they give you stock.”
Now that you know how to invest in startups, it’s time to take the next step. Check out the crowdfunding sites linked above. Or sign up for our free e-letter for more investing opportunities.
About Amber Deter
Amber Deter has researched and written about initial public offerings (IPOs) over the last few years. After starting her college career studying accounting and business, Amber decided to focus on her love of writing. Now she’s able to bring that experience to Investment U readers by providing in-depth research on IPO and investing opportunities.