Everything you need to know about investing in a startup
Wondering how to invest in startups? This article will explain how to invest and explore why you might choose to invest in one in the first place.
What is a startup?
In the simplest terms, a startup is a new business. More complexly, a startup is usually an entrepreneur-founded company in the first stages of its operational existence, hoping to develop a new product or service.
Most startups have high costs and limited revenue, so founders rely on funding/seed capital from numerous sources in these early stages, including venture capital (VC) investors and donations from family and friends.
A startup often has a fully developed business model that it seeks to implement. Sometimes, especially in science and technology contexts, seed capital will be invested in research and put toward expanding the business plan. Thus, transitioning from startup status into a fully-fledged company will take longer.
Why invest in startups?
In the context of an investment, backing a startup is high risk but potentially very high reward. Around 90 percent of startups fail, with 70 percent of this figure closing their doors somewhere between years two and five. The risk of not having enough capital to continue operations before reaching a point of impressive profit is always looming, but so is the potential to soar and thrive. The benefits of investing in startups are as follows:
If you can invest in a successful startup, you could see big returns.
Attractive entry prices make startup investments more viable for new investors.
Including a VC investment (or multiple VC investments) in your portfolio as part of a broader investment plan will help you to diversify and spread out possible risks.
After some market turmoil and confusion, experts are reporting that it’s now, finally, a good time to invest in startups.
Startups can allow you to put your money where your morals are, investing in businesses that challenge the status quo or developing new innovative solutions to improve the world.
How do I invest in startups?
VC startup investments are growing in popularity. The potential gains are enticing, especially when the initial entry price isn’t inaccessible. If you’re hoping to invest in a startup, you need to be aware of the drawbacks and benefits and how the process will work. Essentially, there are three options:
Direct investment – acting as a venture capitalist and directly investing in the startup company.
Co-investment – collaborating with another venture capitalist to invest directly together.
Funds – investing in funds that indirectly invest your money into startups alongside other asset classes, securities, etc.
If you choose the third option, you can expect research surrounding the viability of the startup investment to be done for you by professionals and analysts. You’ll have less control, but you’ll also be exposed to less risk. If you choose one of the first two options, however, you’ll need to:
1. Assess the startup’s “M”s (Management, Model, Market, Money, Momentum).
2. Request a pitch from the founder to set the tone/get all the information you need.
3. Confirm you’ve exchanged all the necessary information:
Business model
Current investment structure
Resumes for team members (if it’s a startup with employees)
Legal information
Pitch document
Product/service descriptions
Proof of traction
Supplier lists
4. Confirm that this is a good, solid investment and a long-term business relationship you’re willing and able to enter into.
How do I know if a startup is a good investment or not?
This is an essential consideration. It should be the most significant factor in investing in a startup.
When it comes to new business ventures, there are no guarantees, but there are signs of legitimacy that you can spot (or fail to spot, on the flipside). If you’re hoping to mitigate your concerns and confirm that a startup investment is in good stead to succeed, you should be attentive to the following:
Any weak links
The amount of capital invested thus far
The atmosphere/ethos/energy of the startup
The company’s cash flow
The company’s data
The company’s physical operations
The market (or lack of a market) for the startup’s offering/s
The skills and track record of the founder
The skills and track record of the management team
The skills and track records of team members (if applicable)
Startup investing tips and tricks
Do your research – don’t jump into an investment because it sounds appealing on the surface or because another person assures you that everything looks good. Do your own research, and don’t be swayed by data you haven’t checked.
Assess the founder – statistics show that older startup founders are generally more likely to see their new business succeed. This is one of many things to remember, alongside being attentive to things like temperament and track record.
Consider the potential ROI – is this startup in a niche market that could explode? Or is it a product/service that’s been offered a million times? What is the likely return on your investment if everything goes as planned? In your gut, do you think it will?
Assess which stage the startup is in – as mentioned above, about 70 percent of startups that fail do so between years two and five. If you’re investing before this point, know the stage the startup is at, and go in with your eyes wide open.
Speak with other investors – talk to a trusted fellow investor if possible. This is especially useful if you’ve never made a VC investment before, as it might give you some essential perspective on the viability of a particular startup.
Consult a financial advisor – it’s always best to consult a qualified, regulated, and unbiased financial advisor before you make any investment decision. They can guide you on the pros and cons and help you make confident financial decisions.
Whether investing in a startup feels right or wrong, speaking to an advisor and carefully considering your investment strategy with professional help could form the basis of your next decisive money move. The most successful investors are armed with knowledge and equipped with the support of an advisor. Contact us today for help managing your growing, promising portfolio.
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Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.