If you’re interested in diversifying your investments, you may look to invest in startups. With the advancement of technology and the frank need to reduce waste and increase efficiency in specific business sectors, the rise of startups has been exponential.
Investing in these early-stage businesses is extremely risky, though also seemingly attractive. If you can get in at the right moment and the company takes off, you can triple your investment in a short period of time.
Not only that, but often, early investors in startups are given an equity stake in the company in exchange. Then, as the company’s value increases, so does the value of your shares. And if it goes public? You are set up to become a multi-millionaire potentially.
However, going back to the risky part of this. Startups and their founders must be extremely good at selling their idea to attract investors.
So good that often you, as an investor, can be fooled into thinking that you’re putting your money into a good thing. There are red flags, or points of concern, though, to be aware of.
To invest in startups, we’ll discuss the top 5 things you should look for or think of when hearing an investment pitch. Before we get into that, here are some other ways you can get involved with startup investing.
How You Can Invest In Startups
There are a couple of avenues you can go through to invest in startups. One is to join an angel investing group.
Angel investors typically come in the super early stages of a company, receive equity in return, and face little competition from the deep pockets of venture capitalists (who tend to come in at later rounds of funding).
Nowadays, there are also startup investing platforms that you can join, such as SeedInvest, WeFunder, StartEngine, and Republic. Through these platforms, you can access companies that have already been vetted. It’s a great way to look into the industry and get started if you’re interested.
You can also join venture capital funds that pool money from investors and then have their fund manager turn around and find the best startup investments. This avenue will likely require more capital.
5 Things To Know Before You Invest in Startups
An intelligent investor and a millionaire have one thing in common – they do not part with their money easily. As exciting as it can be to invest in startups and be a part of something fresh and new, you should proceed with caution and do your due diligence.
When you hear a pitch, keep an eye out for these things:
- The team
- The financials
- The plan to execute
- Proof of concept
- What will they do with your money
The Team
We’ve all seen Shark Tank. The Sharks often fork over an investment based on the entrepreneur and their work ethic.
So, who is the team assembled for this company? Is there a team? What are their backgrounds, and how are they each contributing to the company? Is nepotism involved?
Even if the product they are advertising is un-exciting, a good team that works well together and has a solid vision is more likely to carry the company forward to success. This means that your investment has a higher likelihood of bringing you returns.
The Financials
You don’t need to be a guru at reading financial statements, but you should have a basic understanding of financial questions to ask.
For instance, how much money has been invested in the company, and by whom? Does the company have debt? Have they made any sales? If there are other investors, how much equity were they given in exchange (this will also tell you what THEY valued the company at)?
Financials are an objective measure of what’s going on within a startup and can give you a good idea of how they make decisions, which dictates the path going forward.
For any money that has come in, how was it spent? Anything that smells funny from a financial standpoint should be viewed as a huge red flag.
The Plan to Execute
A company’s plan for growth and next steps can be crucial to its success. Ask many questions here to see if their plan makes sense, if it’s in line with what you think and whether it’s logical.
If you’re unfamiliar with what should happen, ask for data to back up their decisions. Is there proof of concept in the market that’s telling them what to do?
Have they spoken to any advisors within the industry that have given them a path forward? How do they know that their plan is going to work? Which metrics will they follow?
In addition, if their execution doesn’t work and the company starts to fail, what’s the backup plan? Contingencies? How will they pivot?
Proof of Concept
Referencing the point made above, has this company started selling its product? If so, then what are their sales? What’s the level of interest from the public? If they have not started selling, what research did they do to gauge interest?
Has any feedback been obtained? Is there a pilot test for the product or service so that you can objectively know that the company will generate revenue when it’s ready?
Anyone can generate an idea and even execute it, but not everyone may want to buy what’s for sale. A good entrepreneur or team, is fully aware of this and does their best to put in the research and make changes or pivot if necessary.
What Will They Do With Your Investment
Be sure you ask how the entrepreneurs will use your investment! Thoughtful planning for the future and putting the money in the right places can make a huge difference in how successful a startup is in defining its next steps.
As an investor, you have every right to know what the plan is and what you’ll be getting in return.
In addition, you may be asked to invest your time. Ascertain what your responsibilities are after you invest in a startup. Will you be invited to board meetings? Will the startup founders/team want your input on certain decisions?
Many startups are looking for investors that will be able to give advice, along with their money. Understand what your investment will mean by asking these questions!
Bringing It All Together
It can be exciting to invest in startups but also super risky. Knowing the right questions to ask can help you make sure that you are making the best, informed decision possible and also helps manage expectations.
As an investor, you are entitled to what you want to know. Ask questions, spend time with the founders, and research the startup’s industry. The more informed you are, the better off you will be negotiating and understanding the process.
Final Thoughts
Diversifying your portfolio with startup investing can be exciting and expose you to high growth potential. Remember, though, that very few startups end up hugely successful, and even fewer do so quickly. Investing in startups is a long game that can be very fruitful or not at all.
Regardless, when you invest in startups, you are taking a chance on the future, on people, and are learning something new and unique every day. That is worth the investment.
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