Until recently, startup investing was limited to accredited investors. Put simply, an accredited investor is a person or business entity that’s allowed to deal in various securities that may not be tied or registered to any financial or regulatory authority. Although entitled to privileged access, accredited investors must satisfy one or more requirements. These may refer to one’s net worth, income, professional experience, asset size, or governance status.
But thanks to the Jumpstart Our Business Startups (JOBS) Act of 2012, investing in startups is now open to all Americans. That’s regardless of whether they classify as an accredited or non-accredited investor. If you want to put your hard-earned money to work for you, having an investment portfolio of several such startups is the way to go.
That said, it’s important to realize that startup investing is a high-risk, high-reward endeavor. This means that, even if most startups fail several years after their inception, those that do see themselves through will generate you a handsome ROI.
Think of today’s tech giants like Google, Microsoft, Apple, Uber, or Paypal. They all began as startups, some of them in a garage, and all of them are now multibillion-dollar enterprises. The greatest beneficiaries of the rise of these companies are those that invested in them as early-stage businesses.
But before you start investing, however, let’s take a look at the basics of startups and startup investing.
What Is a Startup?
For better or worse, there is no strict definition of the term. While Neil Blumenthal, co-founder and co-CEO of Warby Parker, defines it as a “company working to solve a problem where the solution is not obvious and success is not guaranteed,” others like Adora Cheung, co-founder and CEO of Homejoy, see them more as “a state of mind.”
Key Startup Attributes
That said, there are a couple of key attributes that startups have in common. For starters, they need to be in their early stages of development – typically fewer than 3 years of operation. Second, they need to show strong potential for rapid growth. This can imply that they have an innovative product that addresses a particular market pain point and that they operate in a large and/or growing market. A newly-founded brick-and-mortar corner store, by definition, limits its market and chance for fast growth. Therefore, all startups are new companies, but not all new companies are startups.
It’s worth mentioning that as with all new businesses, startups also have a high failure rate – 90% to be exact. There are several reasons why a startup fails. Lack of cash, the wrong team, tough competed, poor products, or an unsustainable business model, comprise a small list of reasons startups fail. Successfully avoiding these issues are all signs of a successful startup and each factor should be thoroughly analyzed during your research and due diligence. As part of your startup investment portfolio management, the investor also needs to analyze the securities offered and balance the risk and rewards of each individual issue, so as to maximize your ROI on minimum investments.
To see their venture through, most entrepreneurs will look to raise money in several ways. They can turn to venture capitalists, angel investing, and/or equity crowdfunding. We’ll be taking a look at some of these top startup investment strategies below.
Early Stage Investing
Thanks to the JOBS Act of 2012, startups can raise money during their development or market research stages is possible via early stage investing. Do keep in mind that these are also high-risk, high-reward stages, where the risk and rewards need to be calculated carefully. As an early stage startup investor, you will start investing in one of three ways:
- Seed Funding: This is for companies raising money to carry out market research, for proof of concept, product design, or to get their business off the ground.
- Startup Funding: Individual investors can also fund startups during their product development and marketing phases.
- Early-growth Funding: Venture investing at this stage is typically done to boost manufacturing and sales.
These types of early stage startup fundraising will typically be done in exchange for equity in the enterprise.
Angel investors can either be friends and family or high net worth individuals. They can invest in a private startup company either for a piece of ownership or in exchange for some type of convertible debt. As opposed to venture capitalists, an angel investor tends to invest in the founder and not the business, itself. The founder’s experience and character is a strong indicator of success and should be part of your due diligence analysis.
As is the case with venture capitalists, angel investors will use their personal funds as a source of financing, which can be done through a fund, trust, or LLC. Also known as seed investors, angel investors usually bridge the gap between venture capitalists and crowdfunding. Since angel investing is also a high-risk, high-reward investment opportunity, it typically comprises only about 10% of an individual’s investment portfolio.
Among the other top startup investment strategies, most individual investors prefer equity crowdfunding. As a preferred investment for beginners, it generally requires minimum investments and remains open for non-affluent individuals. Put simply, equity crowdfunding refers to raising money from small public investors (crowds), as opposed to donation or reward-based crowdfunding. In some cases investors provide funding for altruistic reasons or in exchange for a small reward. However, equity crowdfunding results in investors owning a small piece of that business.
And as with angel investing, due diligence in equity crowdfunding is a must. Crowdfunding platforms, such as WeFunder, StartEngine, SeedInvest, EquityNet, or Republic, are great places to do your investments in startups. Every crowdfunding investment platform in this list will ensure that all startups in their database are compliant with all US Security and Exchange Commission (SEC) regulatory requirements. This lowers the risk of fraud by enhancing the adequacy, accuracy, or completeness of any information regarding financing regulations.
These are exciting times for early-stage startup investors. But these platforms will not give you any information regarding the risk and rewards from an investment standpoint. This is where KingsCrowd comes in. We will help you make the most informed decisions and lower your risk. If you want to learn more about startup investing best practices, subscribe today!