How to invest in a startup
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- Startup investment opportunities used to be limited to accredited investors with connections.
- But today, there are many opportunities for everyday investors to invest in startups.
- There are risks to investing in a startup, so you should do your due diligence on the company.
Every successful company began as a startup looking for investors who saw the value in its business idea. Startup investments used to be limited to high-net-worth individuals. But nowadays, everyday investors can also get involved.
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What is a startup?
A startup is a recently formed company that that's looking to scale quickly. Startups are typically founded by a small group of individuals with a unique business idea that they want to turn into a reality.
In the beginning, most startups have high costs and minimal revenue. Depending on the type of business, it could take some startups years to earn a profit. For that reason, most founders try to raise funds from venture capitalists and investors.
For example, Airbnb started in 2007 when its founders saw an opportunity to earn extra money by renting out their home in San Francisco. Today, Airbnb has 6.6 million active listings worldwide in over 220 countries. But it took years for the company to receive the funding it needed, and eight years to become profitable.
"Despite a startup's success, it may take several years before your investment yields any returns," says William Bevins, a fiduciary financial advisor and CFP® professional.
How are startups funded?
There are typically three different ways you can fund a business:
- Bootstrapping (self-financing)
- Taking out a loan
- Finding investors
Because of the high costs associated with running a startup, bootstrapping isn't always the best option. Plus, you risk losing your savings if your business fails.
Taking out a loan allows you to retain full ownership of the startup, but you'll have to begin repaying the funds with interest immediately. Plus, applying for a loan from a bank or the US Small Business Administration can be tedious and time-consuming.
That's why most startups raise money through various rounds of investor funding. Venture capital firms want to invest in startups with high growth potential in exchange for a percentage of the company.
4 ways to invest in a startup
How you go about investing in a startup will largely depend on whether or not you're an accredited investor. To be an accredited investor, you need to have earned over $200,000 annually ($300,000 if married) for the past two years. You also need a net worth in excess of $1 million, excluding your primary residence.
Accredited investors who are well-connected will have the most opportunities to get in at the earliest stages of a startup. But there are ways ordinary investors can buy into startups they believe in.
1. Invest through a crowdfunding platform
If you aren't an accredited investor, Bevins recommends looking into different crowdfunding platforms.
"Start-up investing platforms offer a diverse selection of companies and demand varying investments," he explains. "Some of the most influential crowdfunding startups include Wefunder, SeedInvest, StartEngine, and Republic."
You can visit one of these websites and browse through the different startups available. From there, you can decide which companies you want to invest in and how much you want to invest.
2. Buy in when the company goes public with an IPO
Another way to invest is to buy shares during a company's initial public offering (IPO). During an IPO, the company takes its shares public on a stock exchange. At this point, anyone can buy shares and it's a great opportunity to invest in a company's long-term growth.
The downside to this strategy is that you won't see the same returns as someone who invested during the earliest stages. But if the company's stock immediately goes up, you could see substantial returns on your investment.
3. Invest in a friend's startup
Another way to invest in a startup is to reach out to your network and see if anyone you know is trying to fund a startup. Most startups rely on friends and family during the early funding stages before turning to VC investors.
However, you'll need to be well-connected to know about this option. And you should research the startup before investing — a startup isn't always worth investing in, even if you do know the founder.
4. Become an angel investor
If you have the financial means, you can also consider becoming an angel investor. Angel investors are high-net-worth individuals who invest their own money in businesses. Most are accredited investors who themselves have entrepreneurship experience.
Becoming an angel investor is risky and you'll need a way to access new opportunities. You can find opportunities through your network or by working with incubators and other companies that help startups.
What are the risks of investing in a startup?
Everyone likes the idea of investing in the next Microsoft or Amazon. But investing in a company during its earliest stages can be very risky. Most startups fail, and you should be prepared for the possibility that you could lose all of your investment.
Even if the company is successful, it could take years to see results. Once you invest in a startup, you need to have the patience to wait and give your investment a chance to become profitable.
Connor Frischmeyer is the co-founder of Auxo Partners, a finance advisory firm that helps startups make better decisions and grow strategically. He explains that startups tend to be high-risk, high-reward investments.
"Earlier stage startups are typically more volatile, and the reality is that even most professional investors don't knock it out of the park," he explains. According to Frischmeyer, the most common risks that come with startups are conflicts between co-founders, poor cash flow, and market headwinds.
What to look for in a startup investment
When you're considering investing in a startup, you should carefully consider the industry and the company's target market. You should also consider the current market conditions and how that could affect the company's chances for growth.
Look into the founder's background, their experience in that industry, and the company's financial records. The more information you have about a startup investment, the better.
"We look for startups that have founders with an 'unfair advantage' in their space," said Frischmeyer. This could be things like companies that are well-capitalized with access to additional funding if needed, a good product and operational roadmap for where the founders want to take the company, and a favorable industry outlook.