Recently Lyft went public and Uber filed their IPO. There is finally an opportunity for the average investor to start investing in some of the tech unicorns. With this comes the news about the original investors and how much money they stand to make in the IPO. You begin to think wow, I wish I invested then. When Snap went public, one high school invested $15,000 and made millions. There are also stories about startup investors that lost it all. The most public recent example of course is the investors that lost money in Theranos. Whether or not this type of alternative investment will appeal to you will depend on your risk level. Wondering how to invest in startups? Before you make you make your first investment, start by doing your research and learn how to find your first investment opportunity.
Why Invest In Startups?
According to Fortune, while the number of U.S companies continues to grow, the number of U.S. companies that are traded on stock exchanges has plunged 45% since peaking 20 years ago. Additionally, new companies have been completely disrupting traditional business models but many of these companies aren’t yet public. If you only invest in public companies, you are limiting your investment options more so than previous generations.
What Startups Can You Invest In and How Much
First, understand what startups you can invest in and how much are you willing to invest. Certain investments are only open to accredited investors and you’ll want to understand if you qualify before doing research on companies you’re unable to invest in. If you’re not an accredited investor, you’ll want to look further into crowdfunding.
You’ll also have limits based on how much you want to invest. Startups will have different requirements but in general, the later the stage the easier it is to get priced out. Additionally, you need to be comfortable with a lack of liquidity and that you may lose your entire investment. When you invest in the stock market, you can sell any time you want. When you invest in a private company though, you can only sell when the startup provides you the option to do so.
Startup Stages of Financing
Seed funding is the first official round of financing. There are many potential investors at this stage and can range from the founders, friends, family to accredited investors. Typically, this is the easiest time to invest in a startup but it’s also the riskiest. Companies are typically just starting out and they’ll have no proven track record. After raising capital at this stage, a company may decide to pursue a Series A.
For more details on each stage here are two helpful articles:
How to Value a Startup
Investopedia talks here about methodology to use to value a private company. There is a lack of strict reporting requirements for private companies, making it harder to value. If you’re investing in a seed round though, there may be no historical numbers to even look at yet. When you’re meeting with the founder, review their pro forma. Ask a lot of questions about their business plan, about the market and what their exit strategy is. If the business doesn’t have a track record yet, does one of the founders have a history with building businesses from the ground up?
Investing in Startups Negotiation: What Should You Get For Your Investment
When I’ve invested in startups, I’ve yet to encounter a “Shark Tank” like scenario and have always been told this is what they are offering. One company decided not to bootstrap and instead raise initial funding from friends and family. In that case they offered the same deal to everyone – a certain amount of money (say $5,000) equaled a certain percentage of the company. In other cases, the company bootstrapped for a little and then offered a SAFE (simple agreement for future equity) by Y Combinator. With this, founders are able to calculate how much ownership has been sold and investors know how much ownership of the company they have purchased. Understand that if / when the company raises more money your ownership will be diluted.
Where to Find Opportunities to Invest in Startups
The easiest way to find opportunities to invest in startups is to look to your own network. If you know friends that have invested in startups before, ask for introductions. Check your LinkedIn and other social media to see if anyone recently started their own business. Do you have connections that are more likely to know entrepreneurs? For example, everyone has that friend that seems to know everyone. Doctors are known to have high salaries and may have been asked to invest in startups. Do you have any connections that started a Kickstarter to raise money for a business idea – perhaps they will entertain the idea of having an equity partner if you reach out.
There are limitations to advertising that a startup is raising money, so it’s likely you already know people who are raising money, they just haven’t publicly mentioned it. It’s up to you to reach out and let people know you’re interested in investing.
Have you invested in a startup? How did you get started?