Should You Try Your Hand at Startup Investing?
Maybe, if you’re willing to put in the effort.
In mid-May, equity-based crowdfunding finally became legal according to new rules set by the Securities and Exchange Commission (SEC). That means that potential entrepreneurs are no longer limited by capitol, which was once a significant roadblock for would-be investors. Back in 2012, President Obama signed the Jumpstart Our Business Startups Act into law. Also known as the JOBS Act, this piece of legislation was designed to simplify and speed up small business investing. Title III, the portion legalizing non-accredited startup and small business investing, officially went into effect May 1.
Startup Investing Changes: What’s at Stake?
Now that the change is in place, non-accredited investors — or those with a net worth below $1 million — are able to take a stab at startup investing. The idea is that regular Joes will now be able to throw some pennies into the startup pot and hope for some big returns. We’ve all seen the headlines about entrepreneurs making back their money a gazillion-fold. But startup investing isn’t as simple or rewarding as it sounds. You still need a deep understanding of the marketplace and the right connections to get in on the best deals, say the experts.
“Early stage investing is early stage investing,” said Future Investor Founder Mesh Lakhani, who has developed a series of free online courses designed to assist entrepreneurs with investing on AngelList. “It’s the riskiest form of investing. There’s no way around it.”
But in reality, early-stage startup investing may be even riskier than traditional early-stage investing. That’s because, according to a report published by Fortune last year, 90 percent of startups fail. With that being said, there’s still a silver lining to it all. When done properly — i.e., diversifying your portfolio with 30 to 50 companies and using online courses like Lakhani’s — this type of investing can yield some returns over time.
How to Invest in Startups the Right Way
1. Join an AngelList Syndicate — “When you join [a good] a syndicate you’re getting access, experience, due diligence of an investor who knows the ecosystem,” Lakhani said. “Access is the hardest part of angel investing. There are only so many good deals out there, and great founders want the best investors.” You can join syndicates through AngelList with a fee to the syndicate lead and AngelList, which won’t exceed 30 percent total. Syndicate charges carry per deal, anywhere from 10 to 25 percent. This means that if a deal exits, the backer of the syndicate pays that carry percent of the profits to the syndicate lead.
2. Invest in Numbers and Be Patient — As mentioned above, expert angel investors recommend putting your funds into between 30 and 50 companies is always a smart method. Portfolio diversification, just like in traditional investing, is key. “You shouldn’t be investing any more than 5 percent of your net worth into this, and then you have to invest in 30 to 50 companies,” Lakhani said. “It’s not a get rich fast business. It takes seven to 10 years to even see things start working or stop working.” The risk of your investments going to zero is high. So you want to make sure you’re increasing your odds of having an exit. It’s power law of distribution, Lakhani says, so you need a few exits to make up your losses and then some to actually make money.
3. Study Up — Lakhani recommends taking his course and going to angel.co/start to see other content on early stage investing. He also recommends keeping abreast on industry news and signing up for Mattermark Daily to get day-to-day investment insight. We recommend doing your due diligence in uncovering the story behind the businesses in which you choose to invest. Asking the right questions, like why the company didn’t go through a bank to get funding, can help you decide whether or not you’re making a smart decision.
4. Take it Seriously — “This is not something to take lightly,” Lakhani said. “People lose a lot of money in this industry, I wouldn’t want to see that happen in larger volume. Check out my free course, get a feel for the early stage investing landscape, and then make a decision.” Lakhani also pointed out that it can be a bit risky to partner up with startups that are seeking this method of funding, because it may signify that these companies had trouble raising funds from professional early-stage investors.