Startup investing is becoming more prevalent nowadays. Angel investing and seed investing are the two stages of early-stage startup investing in which individual investors can get involved before the institutional investors start to invest in early-stage startups. More people are investing in startups, and a lot more people are considering to invest in startups. Some of the reasons for the increase in interest about startup investing include a substantial increase in the number of startups, the emergence of notable angel investors and seed investors, many investors reaping the rewards of investing in startups that have become successful, and the advent of crowdfunding in startups.
A startup can be a public company or a private company. It is not common for an early-stage startup to be a public company, though there are a large number of early-stage and late-stage startups that have gone public in various stock exchanges across the world. Current and future performance of some public companies is analysed to a great extent by many people and firms, while the remaining public companies are analysed to a lesser extent. The market price of the public stock reflects this future expectation on that stock. So, the below discussion is on startups that are not public companies.
Advantages of investing in startups
The main advantages of investing in startups that are not public companies:
- You get to benefit from the tremendous upside if the startup succeeds. The return on investment can be superlative at the event of startup exit.
- If your investment is significant, you can negotiate with the board to get some insider information on company performance. This privilege will help you to observe better the industry in which the startup is operating.
- If you are part of some notable startup exits resulting in a high multiple of your investment, your reputation as a startup investor is burnished. You can make use of this reputation capital for personal gain in many different ways.
- Depending on the jurisdiction the startup operates from or the location where you live, you may avail certain tax benefits for the amount you invest in early-stage startups. Please consult your tax adviser for more details.
- You will get the satisfaction of encouraging the attempts of some promising entrepreneurs financially. If a venture is meaningful to you at a personal level or is innovative, you will get the satisfaction of being part of that.
Disadvantages of investing in startups
The main disadvantages of investing in startups that are not public companies:
- You will be taking up a high amount of risk, especially with early-stage startups. There is a high chance that an early-stage startup might fail. There is a good chance that even a later-stage startup might fail. There is a good chance that a well-performing later-stage startup might not be able to get the desired exit, resulting in a mediocre return on investment for an investor.
To give you a perspective, angel investing is more aggressive and riskier than an investment in small-cap equities.
- You will not enjoy liquidity for your investment. You will not be able to sell your shares until the startup gets an exit. Some startups allow the secondary sale of shares of early shareholders, but those are few and happen when specific stars are aligned.
- In some jurisdictions, you need to be an accredited investor to invest in startups. This restriction can be overcome if the startup that you are interested in to invest opts for the crowdsourcing model for one of its funding rounds.
- It is suggested that you invest in startups only with your ‘play money’. It is a ‘discretionary fund’ of a size that you are comfortable. The amount in this discretionary fund can go towards investing in risky opportunities in which they believe and understand. Not all people can afford to have play money, and even if you can set aside some play money, it might be less than the minimum amount required to invest in a startup. That said, if the amount of play money you have is not substantial, you may consider crowdfund investing in startups.
- Your investment portfolio can become less diversified.
- Unless you are a limited partner of a venture capital firm or a large family office, you may not get access to invest in later-stage startups. If you intend to invest directly in a startup, you usually can do it only during one of the seed funding rounds before the Series A funding round of that startup.
- It is challenging to be aware of the opportunities to invest in specific startups. Getting access to the startup fundraising deal flow is not easy. Those who enjoy the advantage of quality deal flow will get the opportunity to invest in the most desirable startups.
- You need to devote considerable time to research before investing in a specific startup.