Should You Invest in Startups?
For years, investing in startup companies was "forbidden fruit" for the average wealth builder. Unless you were an accredited investor with a $1 million net worth, or yearly income of $200,00, startups were off limits.
Thing have changed, however. Thanks to new crowdfunding rules passed by the SEC in October, early stage investment is available to everyone. Millions of people can now make small investments in young companies via the Internet.
This is, of course, very exciting. Startups are the long shots of the investment world. They offer massive risk, and extraordinary rewards.
The SEC, cognizant of the fact that 90-percent of startups fail, has built in some limits that average investors must abide by. Investors earning less than $100,000 are capped at $2,000 per investment, or five-percent of their net worth. Investors earning more than $100,000 can invest 10-percent of their income or net worth in startups, annually.
So what does the average investor with no early stage experience need to know? What are the potential hurdles to be cleared? Which variables must be considered to minimize risk?
Let's find out.
Action Plan: What should I consider before investing in a startup?
When it comes to investments, everyone loves to get in early -- and you can't get in earlier than seed stage funding. Startups offer the promise of massive returns. On the other hand, most aren't successful, so it's important to be cautious before investing. Some key questions to consider:
- Do I know enough about this company to invest? Startups are notoriously tricky when it comes to making this assessment. By nature, they have little if any history to consider. Financial documentation is often lacking and revenue may be non-existent. This makes if very difficult to make accurate projections.
- Do I really have access to the best investments? The market for top startups is insanely competitive. The best VCs spend huge resources to uncover the prime investment opportunities. Do you feel comfortable in this environment? Will average investors really get a crack at the best startups? Or are you investing in second-rate opportunities?
- Can I handle having an illiquid investment? Often investors can't cash out until the startup seeks an exit via a sale or an IPO. That may be years down the road. Any gains you see will likely be strictly on paper for an extended period.
- Can I handle the likelihood of failure? As mentioned above, only one in ten startups becomes a success. Those odds aren't just unfavorable -- they are downright intimidating.
Investing in startups is an exciting opportunity for the average investor. New SEC rules have opened up a whole new realm of opportunity. Yet it's critical to be cautious when entering this space.
While the potential rewards are enormous, investors would be wise to give due consideration to the elevated risk.