How to Invest in Startups

Investing in startups might seem reserved for those who millions. While such investors certainly play a role, not all who invest in up-and-coming companies are ultra-wealthy financiers. Many are everyday people, including friends and family of the founders, who are looking to support businesses they believe in.

You may want to consult a financial advisor as you make investment decisions. Speak with your advisor matches today.

What Exactly Is a Startup?

First, let’s define what a startup is. It’s one of those business terms that gets used so much that it can sometimes lose meaning. Knowing exactly what we’re talking about when we discuss startups is key to ensuring you make the smart investment decisions.

In short, startups are companies that were only recently formed. They aren’t part of a larger company. Startups often relate to the tech field, but this isn’t always the case. Startups are generally founded by a small group of people, often friends or business associates, who have an idea they want to turn into a reality.

Many firms that are now considered big companies began as startups, including Uber, Facebook and even Apple. Every great idea has to start somewhere. Today, many startups begin with the help of incubators that provide resources and access to funding for the right businesses.

Why Invest in Startups?

Investing in startups is not the safest of investments. It can be very risky, as many startups fail. As such, investing in startups likely is not the way to provide yourself with a retirement nest egg or to make money for purchases like a house or a new car.

Instead, startup investing is for people who want to take a chance on a company they believe in. It is for investors who believe in the people behind a company and the company’s mission. They want to help the company achieve it, and potentially get some returns in the process.

If you want your investments to be more than just a way for you to make your money work for you, startup investing may be a good choice. If not, there are other options, like investing in stocks or mutual funds, that may be a better fit.

Investing in Startups With Investment Platforms

One of the best ways for lower-level investors to invest in startups is through an investment platform focused on startups. There are a number of platforms available, but most of them work in fairly similar ways. You can go onto the platform and browse the startups available on each platform. From there, you can decide which companies you want to invest in.

Different platforms have different rules around minimum investment requirements and fees to access the platform itself. Make sure to understand these terms before choosing a platform for your startup investing. Here are a few popular options to consider:

• StartEngine: This company includes what was formerly SeedInvest, merging two major players in the space. The minimum investment varies depending on the startup in which you choose to invest, with some as low as around $500. There are a number of options to choose from.

• WeFunder: WeFunder has an investment minimum of $1,000. Companies include “moonshots” (think flying cars and space exploration) as well as entertainment companies and mobile apps.

• FundersClub: Investment minimums at FundersClub depend on the company itself. You must be an accredited investor to use the service.

Investing in a Friend’s Startup

Another way to invest in startups is to find a personal connection to one that’s looking for funding. Many startups rely on people they know for early rounds of funding. Friends, family members, or associates who are in the process of getting a startup off the ground likely will welcome your investment.

There are several reasons why investing in a startup for someone you know makes sense. First off, you can personally ask questions about how the company is going to work. You can get details on the business plan, the mission statement, the hiring schedule and the company timeline. In other words, you can find out everything you want to know directly from the horse’s mouth, which lets you make the most informed investment decisions possible.

For startup investing, passion is key. It makes the most sense to invest if you are passionate about supporting both the project and the people behind the project. For most people, you’ll find no one you are more passionate about supporting than your family and friends, which can make investing in the startup of someone you know a good choice.

Just make sure you are confident in your friend of family member’s ability to follow through on the startup’s plan. By investing in this way, you are blurring the lines of business and personal life. Still be sure think about the bottom line, and be sure you are making an investment you truly believe could pay off.

Become an Angel Investor

An angel investor is an accredited investor who typically provides the first check to startups looking to prove out their ideas. Wealthy individuals generally either provide that whole check or write a smaller check as part of the startup seed round for that business. Being an angel investor is very risky, but it is a chance to help businesses get off the ground and if one hits it big, then you could have quite the return. Plus, it can be a good tax write-off.

The hardest part of being an angel investor, once you qualify, is sourcing opportunities. If you’re not investing in a business for someone you know, then the most common way to become an angel investor is to work with institutions that help startups. You can generally get access to businesses being built at incubators or through your own network if you volunteer to offer business advice or potential funding to businesses.

How to Evaluate a Startup Before You Invest

Before investing in a startup, first understand how the company plans to make money. Look at its product or service, target customers, competitors and business model. A promising idea still needs a viable path to generating revenue.

Consider how much progress the company has already made. Sales, customer growth, contracts or other evidence of demand can show whether the business is gaining traction. Earlier-stage companies may have less data available, which can make an investment harder to evaluate.

Also review the startup’s finances and funding needs. Find out how much capital it has raised, how quickly it is spending money and whether it expects to seek additional financing. Future funding rounds could reduce your percentage of ownership.

The investment terms also matter. Common stock, preferred shares and convertible securities can provide different rights and potential returns. The company’s valuation affects how much ownership your investment buys, so a higher valuation can limit your upside even when the business performs well.

You should also consider when you might be able to sell. Startup shares are generally illiquid, and you may have to hold them for years. An acquisition or initial public offering could provide an exit, but neither is guaranteed.

Finally, size the investment around the possibility of losing it. Startup failure rates are high, and even a successful business may take years to produce a return. Investing only money you can afford to keep tied up or, at worst, lose can limit the effect on the rest of your portfolio.

Bottom Line

Startup investing is not just for the extremely rich and powerful. You can invest in startups even if you have a relatively small amount of money. It’s possible to make your investment through any of the many platforms dedicated to connecting startups with small investors. You can also consider investing in the startup of a family or friend. However, you should still make sure to do your due diligence to ensure you’re making a sound investment.

Investing Tips

• No matter how you want to invest your money, a financial advisor can help you make the right decisions for your situation. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Asset allocation is an important part of your investing plan. Figure out what your portfolio should look like based on your risk tolerance with our free asset allocation calculator.