How to Invest in Startups
Read on if you're interested in getting involved in a company before it goes big.
One of the most exciting ways to invest is to focus on startups and have the chance to get in on the ground floor. If you choose a company that makes it big later, you could potentially turn a modest investment into big gains.
However, startup investment opportunities can be few and far between. In recent years, legislation has made it possible to get involved with a startup business investment, but it's still complicated. Here's what you need to know about how to invest in startups.
How to Invest in Startups
When people think of startup investment opportunities, they often think of venture capital. Venture capitalists (VCs) put a lot of money into startups in the hopes that they will be successful or even go public. VCs hope that eventually, they can sell their stake for a lot more than they put it.
In some cases, VCs also expect to have a say in how the company operates or takes a leadership position to get compensated well in success.
However, a startup business investment isn't just about venture capital. In fact, many “regular people” don't have the millions of dollars usually required to get involved as venture capitalists. Instead, you can find other ways to learn how to invest in startups:
1. Buy During an IPO
One way to invest in a startup is to buy shares during the initial public offering (IPO). With an IPO, the company takes its shares public on a stock exchange, and anyone can buy shares. Maybe you didn't get in on the ground floor, but if you purchase stock on the first day it's available, you could get a chance for future growth. This can be a way to see a return over time without the need for a lot of money.
Some online brokers support IPOs, so you can open an online account and begin trading relatively easily. Several of our suggested brokers for investing in startups include:
2. Investment Crowdfunding
In recent years, Congress has expanded investors' ability to get access to startups by allowing investment crowdfunding. With this approach, you can find a startup on a crowdfunding website and buy ownership in the company for much less than it would take for venture or angel capital. With investment crowdfunding, you put in a small amount, and if the company is successful, you get a share of the success.
Two popular startup crowdfunding websites are OurCrowd and SeedInvest, and there are several other popular options on the market. OurCrowd is for accredited investors while SeedInvest is open to non-accredited investors as well. Finally, you can use platforms like Yieldstreet to invest in individual private equity deals as well as funds.
3. Lend Money Instead of Buying Shares
While we often think of investing in a company is just buying stock, we sometimes forget that we can actually invest and receive a return by offering to lend money to a new company. If you know someone who is starting a company, you can offer a loan instead of buying a share.
With a loan, you charge interest, and the company makes regular payments. You don't have to wait until the company goes public or sees huge success to receive a return on your investment. Instead, you receive payments with interest every month. However, you still run the risk of losing money. And the gains aren't likely to be as dramatic.
4. Use Your IRA
Interestingly, there are funds out there that offer access to startup investing. However, it's important to note that some of these funds may not be widely available to the public.
You may need to look for an IRA custodian specializing in alternative investments or other types of assets. However, if you can get access to these funds, it can be a way to add tax-advantaged growth to your retirement portfolio by getting access to startups.
Self-directed IRA providers like Rocket Dollar are an excellent place to start since it works with numerous VC and startup investing platforms.
5. Turn to Your Network
One final way you can potentially get involved with startup investing is to turn to your own network. Companies sometimes have a “friends and family” round before doing a larger raise with outside investors and VCs.
Of course, you need to have the contacts to know about these more secret rounds. And just because an idea comes from friends or family, doesn't mean it's a good idea to invest in.
How to Find Startups to Invest In
When looking for how to invest in startups, it's important to pay attention to where you're getting your information. There are different places to look for startups. If you have a large amount of money, it's possible to speak with a boutique advisory firm to help you identify different startups to invest in.
However, it's more likely for many regular investors that you'll have to take other steps to find startup investment opportunities. Some possibilities include:
- Investment crowdfunding platforms
- Your local Chamber of Commerce to find local startups
- Innovation hubs in various cities that showcase different fledgling companies
- Startup aggregators that use AI to help sort different options
- Incubators (like Y Combinator) that help nourish and mentor company founders
Tips for How to Invest in Startup Companies
If you decide you want to use startup business investment as part of your investment strategy, there are some things you can do to increase your chances of success. Here are some things you can do as you figure out how to invest in startups:
1. Run the Numbers
Take a look at the numbers offered by the startup. Are they raising money from sales of products and services? If so, that is a good indication that they could be on their way to success.
You should also figure out how many shares your investment will actually buy. It's hard to know for sure what a startup is “worth” because valuations are so hard to figure out. However, you can run some numbers to figure out how many shares you're getting with your investment. Later, more shares could mean greater wealth.
2. Look at Management
One of the things venture capitalists do looking at the team. For some venture capitalists, the team could be more important than the product. What skills do the founders and executives of the company bring to the table? Do you think they'll provide good leadership? Are they flexible enough to pivot if needed?
Understanding the background before you move forward can make a big difference later.
Just as you do with regular investments, consider diversification. If you have some money to invest in multiple startups, think about how to get exposure to different opportunities. Putting everything into one basket or banking on one company, making it big, could result in disaster. A relatively small percentage of startups make it big, and if you want to increase your chances of success, you need to consider various options.
4. Consider the Rest of Your Portfolio
Remember, your startup business investment is just one portion of your portfolio. And this investment should fit with the rest of your portfolio. Don't empty your long-term retirement savings to put everything into a single startup. Look at your overall goals and figure out where the startup fits in.
When deciding how to invest in startups, ensure it's part of your overall portfolio, rather than something that doesn't make sense with your direction and overall strategy.
Pros & Cons of Startup Investing
Investing in Startups is Not an Easy Process
Investing in startups can be a way to add some growth to your portfolio and give you a chance to see some solid success. However, learning how to invest in startups requires patience. You need to be careful about what you add to your portfolio. It may be a good idea to consult with a financial advisor.
Take some time to research the options and do your due diligence. And as always when investing, avoid putting in money you can't afford to lose.