Investing in businesses has been what smart, successful and rich people have been doing for a very long time. When business owners or prospective business owners need money, they turn to wealthy investors. In times past, investing in startups was seen as an exclusive preserve of wealthy people in the society. However in May 2016, a law took effect that allowed anyone to invest at least some of their cash in startup companies.
These days there are a lot of crowdfunding platforms like Kickstart as well as other methods by which someone can easily invest in startups and own a stake in the business, and still have the ability to cash out — potentially after making big gains.
With the Jumpstart Our Business Startups (JOBS) act, anyone can invest in certain vetted startups. Vetted in the sense that they have been listed on an online debt or equity crowd funding portal that itself has been cleared by the Securities and Exchange Commission and the Financial Industry Regulatory Authority to list startups raising money. It is now up to these portals to prove that people who intend to invest in what they have to offer are protected from theft or computer malfunction, and nobody is engaged in unethical acts of pay-to-play.
Imagine if you had invested about 10 thousand dollars in a company like Amazon, Dell or Samsung before they went IPO, today you will have reaped millions in returns. If you have invested way before they got to the IPO stage, it would have even made you more profit.
It is good to note that investing in startups is not without its very own risks. For starters, a lot of startups fail. In fact about half don’t even make it past four years. And for a lot of them that manage to survive, the value of your equity in the company might not be realized for years, when the company is acquired or when it goes public. In addition, due to the fact that the company is new, you are not likely to earn any dividend because all the profit that the business makes will be plowed back into the business to foster growth.
However, to get around this, you can make use of platforms that allow you to loan money to the company instead, in which case you’ll see regular but lower returns from interest payments. For example, a platform like NextSeed allows you to lend money to certain types of startups, and then they pay you back at a guaranteed interest rate of 15% (except in the case of default, which is always a risk). A loan is not the same as an investment which does not make any guarantee on your money.
How to Invest in Startups
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1. Crowd funding
If you have like say $10,000 that you are willing to invest (and can afford to lose) there are a lot of crowd funding platforms that you can take advantage of. Some of the most popular ones are SeedInvest, NextSeed and WeFunder.
This platform offers equity funding for dozens of startups, even though some of them are reserved specially for wealthier investors (officially known as “accredited investors”— investors with net worth’s exceeding $1 million or annual income of $200,000). This platform is a fully regulated broker-dealer, which means that they go the extra mile to vet the companies that appear on their platform.
Make no mistakes, being “vetted” is not a guarantee that the company will be a success, it just means that they would have taken away some of the challenges you would have faced in doing the background check yourself. They charge a 2% non-refundable processing fee (up to $300) per investment.
This platform is a debt financing crowd funding. What it does is that you are giving loans to startups. Nextseed does not offer any share in the companies but you do provide needed funding to the companies and you get guaranteed returns. NextSeed is free to invest with.
According to their official website, WeFunder is the largest funding portal by dollars raised, number of companies funded and number of investors: more than 100,000. However, they are not a broker-dealer, so they’ve done less due diligence on the companies they advertise. WeFunder charges investors up to 2% of their investment (minimum: $7, maximum: $75).
2. Angel investing
Angel investors are also known as private investors, angel funders or business angels. If you are rich enough to invest in private businesses or startups with the aim of making profits or/and owing a part of the business, then you can become an angel investor.
As an angel investor, you can choose to invest in a business either individually, through groups or through networks. Many angel investors are current or former business owners and as such they are more hands on. They will want to have a say in the major decisions and also provide advice because of their wealth of experience.
You can become an Angel investor through any of the following ways.
By joining Online platforms
These are websites that present small business in need of investments. They prospective investor simply goes through the portal and identifies business that they will like to fund. These online platforms include Angelsoft, Keiretu Forum, and New England Network et al.
These are organizations that are made up of individuals who pool their resources together in other to invest in businesses. According to the ACA (Angel Capital Association), there are over 250 angel groups in the United States of America alone. The ACA website provides a listing of all the angel groups in the United States. You can join any of the various angel groups and become an angel investor.
These are angel investors who neither belong to angel groups nor peruse any online platform seeking for whom to fund. A recent study indicates that there are about 150,000 active angel investors in the United States and you can be one of them.
Venture capitalist (VC)
These are usually professional public or private firms who provide funds to businesses with high growth potentials but with high risk tendency. The funds they provide are usually for businesses that are already up and running but need more money for expansion but they also fund startups.
The website of the National Venture Capitalists Association offers general information about venture capitalists and a list of venture capitalists that are based in your locality. In addition, they also provide advice and statistics about venture capitalists.
Here are some tips that will help when you are looking for startups to invest in
Don’t follow the herd
Just because other people are investing in a particular startup is not enough reason to jump into the band wagon. It is not uncommon to find people who think that if everyone is investing in a particular startup then it must be the wisest investment out there. Would you harm yourself if every other person was doing the same? Make sure that you carry out your research properly before you make any investment into a startup. This can be by seeking advice from other investors and even the company itself.
A startup named Juicero managed to raise over $100 million, thanks to the help of many venture capitalists, however, it shut down operation just four years after it was founded. Many bet big on its product due to the people that backed it. Don’t be one of them.
Invest only what you can afford to lose
Saying that investing in startups is risky at this point is already a cliché. You can either gain a lot of money or lose a lot of money. This is why you should make sure that you can afford to lose any amount of money you throw into a startup.
Diversifying the startups you invest in will also increase your chances of success. Putting all of your chips on black can result in a big return, or a complete loss. If you spread your startup investment chips across board, making smaller investments in more startups, you increase your chances of walking away with some money in your pocket at the end of the day.
Know the team behind the company
It goes without saying that those behind a company are those that will determine the direction and future of the company. There’s no written rule that applies to every single startup, but a combination of the following is a good place to start;
- Technical and business-oriented co-founders
- A team that complements each other
- Previous experience in the industry they are facing
- Co-founders trying to solve a problem they previously had
Trying to make a concrete judgment of a product at the early stage when all you have is a working prototype, is not an easy task. If your research uncovers that the startup’s product is not supported by valuable metrics, investors will have to make a decision to invest or not based on their gut feeling or previous experience in the space.
You should bear in mind that a good product is not enough reason to invest in a company. There have been many instances of companies who even though they have a good product failed to get users and traction. Oftentimes, the reason for this is that the product itself is not geared towards solving a major problem or is still in search of a problem, or that it’s not the right time for that product.
Size of the market
The size of the market that a startup is in might influence its future growth. An interesting aspect about this is that the size of some markets is not clear at the early stage, when a startup is just getting launched. Airbnb is a good example of this. The company probably did not expect to steal clients from hotels.
6. The company should be scalable
This means the company can grow quickly in revenue while still managing to keep expenses at the barest minimum thus resulting in a healthy profit margin. Some businesses are easily scalable while some are not. Consider a startup that intends to go into the manufacture of ball point pens. The pens can be produced at a low cost and as such, is a scalable business when compared to a company that requires a lot of customization or expert time in installation or consultation.