Investing in Startups: Benefits, Tips, and Strategies

A startup is a new company that is founded by one or more entrepreneurs. It’s usually in its early stages of operation, which means the founders are growing their customer base and developing new products. Investing in a startup allows you to buy into a new business that could potentially become a major enterprise. You can either take a passive role in this investment or actively sit on the startup’s board of directors. 

There are benefits and drawbacks to investing in startups, so you need to be strategic about how you invest and which companies you work with. Use this guide to learn more about startup investing. 

Benefits of Investing in a Startup

There are multiple reasons to consider investing in a startup company. Here are a few benefits of this option:

• You can fund a project that you believe in.
• There is a potential for a high rate of returns if the small startup grows into a large company.
• You can diversify your investment portfolio beyond stocks, bonds, and real estate. 
• You can meet with other investors and grow your professional network. 

There is also a lot of flexibility in the amount you invest in startups. In some cases, you can support an entrepreneur’s dream for only a few thousand dollars. 

Drawbacks of Investing in a Startup

Investing in a startup presents a fun and exciting opportunity to diversify your portfolio; however, there are several drawbacks to keep in mind.

• Startups have high failure rates. An estimated 75% of venture-backed startups fail, many within their first few years. 
• You cannot liquidate the investment. Unlike stocks and real estate, which you can sell, the startup keeps your money until the founders can pay you back.
• You do not have much control over the actions of the startup. While you can sit on the company’s board, you may be outvoted by other directors or the founders. 
• Startup investment is often emotional. You might not make objective decisions that are good for the company.

Emotional attachment often occurs if you become friends with the entrepreneurs or knew them before you decided to invest. It is hard to confront your friends when they are not making strategic operational or financial decisions. 

Challenges Related To Investing in a Startup

If you decide the benefits outweigh the drawbacks, consider moving forward with your startup investment. Here are a few potential challenges to review and develop plans to overcome:

• Evaluate your investment capital. Unlike stocks, start-up investment usually requires a few thousand dollars at a minimum. 
• Know your ideal investor relationship. Clearly define whether you will be involved in the decision-making of the new company to avoid ambiguity. 
• Clarify your repayment and future dividend expectations.

You can overcome many of these challenges with experience.

How To Invest in a Startup

There are multiple ways to invest in startups. Here are a few steps you can take if you want to buy into a budding business. 

• Review the business plans, and make sure that you trust the founders.
• Consider how much each startup is asking for in investment funds.
• If you decide to invest, develop a contract with the startup. 

Once you have invested your funds, keep track of the startup by following its marketing efforts, business acquisitions, and growth. 

Tips for Investing

If you are new to investing in startups, follow these tips to increase your chances of success:

• Look for companies that have detailed business models and clear financial reporting.
• Stay involved in your investment. Attend board meetings and review annual reports. 
• Learn about the industry you are investing in so you can keep up with changing trends.
• Consider spreading your investment across multiple companies in different industries. 

If the startup fails, do not blame yourself. Entrepreneurship is difficult and several factors will contribute to the business going under. 

How To Find Startups To Invest In

In 2023, more than 5.5 million new business applications were filed in the United States. This means there are millions of opportunities for you to invest in new companies. Here are a few ways to find startups to invest in:

• Attend entrepreneurship conferences and seminars
• Join online investing groups and websites.
• Get involved in your Chamber of Commerce to support local businesses.
• Work with an investment group that will find and refer startups to you.

You can either get involved in local small businesses in your area or invest in startups across the country — or even across the globe.

How Much Should You Invest?

The Securities and Exchange Commission (SEC) has guidelines for how much you can invest in startup ventures. If your annual income or net worth is more than $124,000, you can invest up to 10% of your net worth. If your annual income or net worth is less than $124,000, then you can invest up to 5% of your net worth. You can either decide to invest in a single company or spread your $5,000 across four or five investments. 

If you are interested in launching a startup on your own, then you don’t have to follow these SEC guidelines. You can pull from your equity or seek out investors to support your entrepreneurial idea. 

Here are a few additional ways to fund your investment:

• Take out a Home Equity Line of Credit (HELOC): Some people find the returns of their startup investment exceed their mortgage interest rates, which makes it worth it to take out a HELOC. 
• Look into stock loans: A stock loan allows you to borrow money against your publicly traded shares. This is a form of securities lending that uses your stocks as collateral. A secured loan might give you better interest rates that make borrowing more affordable. Use the stock loan calculator to determine how much you can borrow. 
• Partner with investor groups: If you don’t have a lot to invest, you can work with other parties and pool your resources. 

Know how much you are willing to invest before you start meeting with founders and reviewing business plans.  

Stock Launch for a Startup

If the startup you invest in is successful, it might decide to go public through an Initial Public Offering (IPO). Investors typically own a significant portion of the company even with the IPO. The company will need to work with the SEC to go public and sell its shares. 

Platforms To Invest in a Startup

Multiple online platforms can help you invest in startup companies. Here are a few different options.

• StartEngine: Crowdsource startup companies and clearly see how many investors each new business has. 
• Wefunder: Invest on a micro level for as little as $100 with a median investment of $250.  
• Seedrs: Diversify your startup portfolio across a variety of industries on their platform. 
• MicroVentures: Join more than 200,000 investors in supporting various entrepreneurs. 

Investing in startups is a unique way to diversify your portfolio and help new businesses grow. Once you understand the risks that come with this option, you can work to mitigate them and increase your chances of success.