By Omar Sacirbey
Copyright benzinga
Investing in startups can be one of the most exciting and lucrative ways to make money, and it’s also become a lot more accessible. A field that was once reserved for investors with deep pockets has opened up to retail investors who can now get in on breakthrough companies that have the potential to offer big returns.
But along with that promise of double- or triple-digit multiples comes a high level of risk.The majority of startups fail, and investors who backed them stand to lose everything.
This article will break down the reasons investing in startups can pay off, what to watch out for, and how to get started responsibly.
The Appeal of Startup Investing
Investing in startups is exciting. As an early backer, you have the potential to get in on a business that’s new, innovative, solves a problem, or is just flat-out revolutionary.
Think of Uber or AirBnB, which completely disrupted the car service and lodging industries. Each startup created new markets with thousands of newly created drivers and hosts. Suddenly millions of consumers with disposable income had more car and lodging options than ever before, and they were often cheaper, faster, and more flexible than what already existed.
Common traits that made Uber and AirBnB successful included leveraging technology to bring solutions (expanded car service and lodging options that are affordable and easy to order) to problems (a limited and expensive stock of car service and lodging options), and thereby disrupting two well established industries.
Early-stage investing made multi-millionaires out of those who made bets on startups like Uber and AirBnB, but only accredited investors with more money at their disposal could gain access.
Nowadays, however, such investment opportunities are also available to non-accredited investors, thanks to equity crowdfunding, Regulation A+ stock offerings, and other means that are made possible by regulatory reforms enacted over the last decade or so.
Potential Returns and Growth Opportunities
There are many benefits of investing in startups, and the potential for exponential returns is the No.1 attraction. Traditional investments in shares of publicly traded companies typically grow more gradually, with stock prices rising and declining along the way, and their overall returns are more modest.
Investments in privately held startups, on the other hand, can reap returns many times over the original investment. Indeed, an investment of just a few thousand dollars can become millions if placed with the right business.
According to Brian Nichols, founder of angel fund community Angel Squad, a $5,000 seed investment in Uber in 2010 was worth almost $25 million in 2019 when the company made its initial public offering. A $5,000 seed investment into AirBnB in 2009 would have become $35 million at the company’s 2020 IPO.
Those investments grew exponentially because those startups grew exponentially and quickly, highlighting some of the common characteristics that startups share: They address and are accessible to a large market, they can be scaled rapidly, and they leverage technology in a disruptive way.
That means that breakthrough startups aren’t only found among service sector businesses like AirBnB and Uber, but in scores of other sectors including artificial intelligence, communications, computer hardware and software, finance, transportation, and medical and health sciences, to name a few.
Diversification Beyond Traditional Assets
The potential for outsized startup investment returns is just one factor that makes this asset claass well worth considering as part of any non-accredited and accredited investor’s portfolio. They can also be a great way to diversify. startup investment returns
Most retail investors tilt heavily toward publicly traded securities such as stocks, bonds, mutual funds and exchange-traded funds (ETFs), all of which are tied to the performance of the public markets.
Investing in startups, on the other hand, is not linked to stock market performance. Instead, startup investments are linked to the growth and success, or decline and failure, of individual startup companies. When public markets fall, they’re not going to take startups down with them, which can help offset potential portfolio losses.
Keep in mind, however, that startup payoffs, in the form of an exit event such as an IPO or acquisition, can take a decade or more to be realized, tying up your money in the company in the meantime.
Risks to Keep in Mind
Limited liquidity and a long timeframe before a startup investment pays off are just a couple of the downsides. One of the biggest risks of startup investing is business failure.
In fact, most startups fail. It’s a harsh reality that shouldn’t be surprising, given that untested companies face a slew of possible pitfalls such as inexperienced management teams, overestimated sizes of target audience, overlooked competitors, and products that just aren’t as popular as startup founders expected them to be.
That’s why due diligence is crucial. Investors with the opportunity to put money into a startup should first rigorously vet the business. This includes understanding the product or service that’s being offered, whether or not there’s a demand or a market for it, whether the business model is workable and scalable, and whether the management team has the competence to help the business achieve its goals.
How to Start Investing in Startups
Anyone who wants to begin investing in startups first needs to determine whether they’re accredited or non-accredited. Each type of investor has paths they can take, but accredited investors have more opportunities.
To qualify as an accredited investor, an individual must either have a minimum annual salary of at least $200,000, or assets of more than $1 million, not including the individual’s primary residency. To qualify as an individual with a spouse, the minimum annual salary required is $300,000, or assets of at least $1 million, not including the couple’s primary residency.
Accredited investors can invest in startups as angel investors and venture capitalists, providing seed capital either directly to a company or as part of an angel network.
Non-accredited investors can also put on their venture capitalist hats by investing in startups through so-called Regulation A+ stock offerings, whereby private companies offer unregistered stock with less stringent reporting and disclosure requirements.
Another option is equity crowdfunding. On some platforms, non-accredited investors can start investing in startups with as little as $100 to $500.
Does Startup Investing Belong in Your Portfolio?
While there is potential for great returns, there are also substantial risks of startup investing that could lead to financial ruin. Potential investors must thoroughly research the startups they’re considering while viewing them as a part of a balanced portfolio and not a replacement for core investments.
Frequently Asked Questions
