How to invest in a startup
Offering the precise definition of a start-up can be a challenge… When talking about a “start-up” one may be referring to:
- An established company that creates a new product or service under conditions of uncertainty (no guarantee of success).
- Or a new company that seeks to solve a problem or satisfy a need through a non-guaranteed solution.
Regardless of how a start-up is defined, this type of business normally to requires large amounts of money and good connections to invest and earn. However, this has changed through crowdfunding platforms. Any investors, regardless of their access to capital or connections can invest in start-ups.
Theoretically, the initial investment is potentially lucrative, but comes at a great risk as majority start-ups eventually don’t make it.
Taking the risk in account you can invest in start-ups with the potential of generating high returns.
In order to do so we recommend you the following advice:
Platforms to invest
Ordinary people can invest in start-ups through crowdfunding platforms. Start-up investment platforms offer a thorough selection of companies in which the individual will be able to invest for a minimum capital
The main players in the crowdfunding start-up space are:
“Thousands of companies apply to raise funds on our platform every year, and we approve only about 3% of them,” says Kendrick Nguyen, CEO of crowdfunding platform Republic.
Most of the sites noted above allow you to start investing in start-ups with as little as $100, while SeedInvest requires at least $500 of investment.
AngelList is a leading platform in the start-up investment field, but only admits accredited investors with income of at least $200,000 ($300,000 if married) or a net worth of at least $1 million, excluding your primary residence. Minimum buy-ins on AngelList are at least $1,000.
Here in Brickken, we have a established the minimum investment to be of 100€, but our business model is completely different from other crowdfunding platforms, as we tokenize the startup, so the investors can engage in new business models created on top of the token issued by the startup.
How much can I invest in startups?
Non-accredited investors (anyone who does not fall within the definition of an accredited investor) should note that there may be a limit to investing in crowdfunded companies during any 12-month period.
According to SEC guidelines:
- If your annual income or net worth is less than $107,000 you are allowed to invest up to a maximum of $2,200 or 5% of your minimum annual income or net worth.
- If your annual income and net worth are equal to or greater than $107,000 you may invest up to 10% of that amount. This amount, however, cannot exceed $107,000.
Natural persons residing in the European Union who have expressly requested to be considered a qualified investor and who meet at least two of the following three conditions:
- The Client has carried out transactions, of significant size, on the relevant market at an average frequency of 10 per quarter over the previous
- The size of the Client’s financial instrument portfolio, defined as including cash deposits and financial instruments, exceeds 500’000 Euro.
- The Client works or has worked in the financial sector for at least one year in a professional position, which requires knowledge of the transactions or services envisaged.
Just because you can invest a certain amount in new ventures doesn’t mean you must invest everything allowed. The right amount to allocate should not be more than the investor can comfortably lose if the startup goes bankrupt or takes a particularly long time to pay off. Experts generally recommend making several small investments in different start-ups, rather than one large investment in a single start-up. In fact, AngelList even writes in its investment guidelines that “you should only invest if you have enough capital to make 15 to 20 initial investments.”
This provides diversification, since if you invest in five start-ups and four of them fail, you still have a winner, which can help protect or recover some of your initial investment.
How to make money investing in startups?
When you invest in a start-up through a participatory funding or crowdfunding site, you sign an investment contract with the company. Generally speaking, there are four different types of investment contracts, each of which offers different ways to make money on your investment, these are:
- Debt. This type of contract treats your money as an interest-bearing loan. The contract can pay a fixed return (such as two times your investment) or a variable return. If you receive interest, payments depends on how the company performs over time.
- Convertible note. Instead of earning interest, this contract is a form of debt that converts into shares of the company when certain milestones are reached, such as closing a round of financing. You earn money on your investment once the company is purchased by another company or eventually goes public.
- Stocks. At a later stage start-up can allow you to buy stocks in the company, just as you would buy stocks in a publicly traded company. You should keep in mind that you cannot sell the shares from the start-up. To make money, you must hold on to your shares until the start-up goes public or is bought by another company.
- Dividends. Start-ups that successfully reach the operational consolidation stage may eventually offer investors the ability to buy shares that pay annual dividends.
For these and other reasons Bitcoin and other cryptocurrencies are the perfect environment for speculators to proliferate, and are looking for high rentabilities without considering the risks associated with these type of investments.
Why invest in startups?
Investing in a new business idea (startups) places you in a privileged position in the process of developing new technologies or solving a problem. It also brings the following benefits:
- Growth potential. Large-cap stocks in the S&P 500 are much less risky than a start-up, but there is rarely room for exponential growth. However, if you invest in a successful start-up, the sky’s the limit. “There’s plenty of opportunity for expansion,” says Tom Schryver, who teaches “entrepreneurship” at the SC Johnson College of Business at Cornell.
- Belief in a new idea. The initial investment may appeal to you because these are entrepreneurs pursuing a new idea. People often invest in what they want to see in the world, whether it’s more sustainability or a really cool tech company.
- Personal connections. Maybe a family member is launching a great new product, or maybe it’s your neighbour. It sounds like an innovative idea and you want to help fund a friend or family member’s project.
- Feeling of fulfillment. For some investors, start-up investing is something they do for the feeling it gives them: helping someone find a business, seeing something new being created, learning about different industries or getting in on the first floor of something exciting.
Why not to invest in startups?
Startup investing isn’t for everyone, least of all investors who want stable, recurring, low-risk income. Startups are very risky. Approximately 90% of all start-ups end up closing due to a lack of fit between product and market, marketing problems, team issues, among others.
In general, start-ups are only a good investment if you’re prepared to lose 100% of what you’re betting. Ideally, the vast majority of your capital should be invested in index funds and exchange-traded funds (ETFs), or even just individual stocks. Start-ups are illiquid investments. If you were to buy a share of a publicly traded company and change your mind tomorrow, you could easily sell that share in the public market. Start-ups are generally very illiquid. When you invest in a start-up, you should keep in mind that the capital will be tied up for at least three to five years, if not longer.
It takes time to see results. Even if a startup is successful, it may still take several years before a result from your investment materializes.
How to decide if a startup is a good investment
How you approach the initial investment will be unique to you and your financial situation. Experts recommend doing a lot of research before you risk your money. You should be able to answer these questions before making an initial investment:
- What do you know about the startup? Is it a field, industry or product you are familiar with? Wefunder recommends investing only in things you understand.
- Is the team passionate about their idea? Even a can’t-miss idea can fail if the team isn’t committed to getting it off the ground.
- Does the startup have domain expertise? The startup must know the difficulties of the geographic space in which they are operating.
- How big is the market? Having a large and growing market is crucial for startups. Companies sometimes target a niche and develop a product that is so focused that even when they outgrow the competition, there is no way for them to become a big company.
- Why this, why now, has this idea been tried before? If not, why not? If so, why did it fail previously?
Should you invest in startups?
The question of whether or not to invest in startups depends largely on your circumstances. Are your finances in good shape? Are you having difficulty paying your debts or reaching your savings goals? That is why, in the past, startup investing was only available to accredited investors who already had substantial incomes and high net worth.
Now that crowdfunding platforms have made it possible for anyone to invest in a startup, experts recommend keeping the following principles in mind:
- Talk to your financial advisor. Your financial planner will not be the one to bring up investing in private, high-risk startups, so you’ll need to initiate the conversation.
- Invest only small amounts. Because of the high volatility in the space, advisors recommend sticking to a small portion of the total investment.
- Be prepared to lose it all. The money you invest in startups should not be the money you’ve put toward your children’s college education or retirement. To the extent possible, this should be your investment “fun money,” meaning that if your bets fail, you will not lose your home or mortgage your future.
If you want to invest in startups through tokenization, then join Brickken now.