How to invest in a startup business
Investing in a business can reap rewards, both financially and personally. Individual investors typically put their time and money in companies they feel passionately about. In addition to giving the company money, they take part in major business decisions. Many angel investors act as mentors for new CEOs and leadership teams, and they enjoy imparting the knowledge they’ve gained over their years doing business to build a new company that encompasses values they believe in.
If you’re just getting started investing in businesses, then you’re probably interested in becoming an angel investor. If you’re coming off the sale of your own company, or you just want a chance to experience the other side of business, angel investing can be a lucrative way to make some money and help out a growing business in the process.
There are a few things to know before you get started investing in a startup business.
How to become an angel investor
You can’t just decide to become an angel investor on a whim. Well, I suppose you can, if you’ve been making a steady paycheck of over $200,000 for at least the last three years. But you’re going to need to spend some time determining whether or not you meet the criteria to become an accredited investor before you can move forward making angel investments in small businesses.
The good news is there isn’t a formal process to become accredited. You don’t need to file paperwork or get any official certifications. Being an accredited investor simply means you make enough money that businesses can trust you to be able to fulfill your part of the financial obligation. Individuals need a net worth of at least $1 million (not including your primary residence) OR to have grossed at least $200,000 annual income over the last three years. If you’re married, then you need to meet either the $1 million net worth mark OR have grossed an annual income of at least $300,000.
If you don’t meet that criteria yet, don’t give up! You can still invest in startups. You just can’t do so as an angel investor, which means some opportunities will be closed to you. There are ways for unaccredited investors to still invest in companies. You can participate in crowdfunding opportunities, which often start at an even lower price than angel investment opportunities. These can be a great way to get your feet wet in the investment world, while you wait for time to pass so you can meet the accreditation status. Some of these opportunities come at a low price, as low as $5,000, so they can help you figure out investing without putting up a whole lof of money at once.
Why invest in startups?
Investing in startups can be risky. If you ran a business before deciding to start investing, then you are likely already well aware that there are about a million and one things that can go wrong with a startup venture. That’s why so many of them fail within the first few years. But, when things don’t go wrong and go 100 percent right, you can end up with a huge ROI (think of startups like Facebook or Nest).
It’s important to go into angel investing knowing that the chances of the startup you’re investing in becoming a billion dollar business aren’t high. That doesn’t mean you should assume the worst. It just means you shouldn’t get carried away, assuming every company you put money into is going to be “the next big thing” and end up investing more than you can afford to lose (and you probably will lose some money along the way). This risk is part of why there’s an accreditation standard, to protect investors from putting up more money than they can afford.
A lot of angel investors invest in multiple companies, because of the risks involved. Investing less money in more companies can be a great strategy to increase the likelihood of getting a good ROI. It can also make things more fun for you as an investor, since you’ll be exposed to the inner workings of multiple companies. Angel investors can learn just as much as founders by going through the investment process.
How does startup investing work?
You might be approached by a business owner who’s looking for investors to back his or her business. Or, you might seek out companies to invest in through an investment network like CapitalRaisingClub.com. Once you get into angel investing, you’ll probably end up with more pitches than you can keep up with, so make sure to be picky about what types of investments you are and aren’t intersted in.
Whichever way you end up finding companies to invest in, the process of investing is the same. When you invest in a startup, you’re essentially buying equity in the company, which gives you an ownership stake in the startup along with rights to its future profits. You form a partnership with the company. Unlike investing in stocks where you buy stocks and then can just sit back while the company runs things, as an angel investor, you’re actively involved in the success of the business. This doesn’t necessarily mean you’re on hand for day-to-day tasks (although you might check in frequently during especially hard times or in the very early stages). But you should see your role as somewhat of a mentor, and you should offer advice to the company when you have an idea for how to move the business forward.
Because you work closely with startups as an angel investor, it’s important that you get along with the startup leadership team. Assessing the startup team before you invest will give you a good idea of whether you believe you’ll be able to work well with the leadership team for the next 7 or so years. If not, then move on and invest in a different company. Disputes between investors and the leadership team are one of the top reasons startups fail, so avoid this by not investing in companies with leadership teams you don’t gel with.
How do you make money as an angel investor?
Angel investing is a long game. You’re not going to get your money back right away. In fact, it takes on average about 7—10 years for a startup to have a liquidity event. A liquidity event is when the startup’s shares go from being illiquid (meaning, nearly impossible to sell to anyone other than other people in the company) to liquid (meaning, possible to sell to the public).
Liquidity events usually happen in one of two forms: an IPO or an acquisition.
IPO vs. acquisition
During an IPO, or initial public offering, the private company’s stock goes on sale to the public. This is what the phrase “going public” refers to.
When a company goes through an IPO successfully, the price per share of stock is significantly higher than it was before the sale. This makes your holdings more valuable, so that if you decide to sell some, or all, of your shares on the public market, you can cash in and get more back from your original investment. Cashing in your assets is also known as liquidating your assets (assets in this case refer to your equity shares in the company, which you can turn in for cold, hard cash).
After a company goes public, the leadership might change hands from the existing board to the new board that’s put in place through the election of shareholders, which includes people who have bought stock on the public market. If ownership keeps enough shares to maintain the controlling stake, then the leadership team can stay in place.
During an acquisition, the private company is bought by another company, generally at a premium that can give investors a potentially higher return than they’d receive during an IPO. Company leaders who want to make a clean break from the company to pursue other ventures might prefer an acquisition, since it means they can more easily make an exit.
For investors, you can get a return with either exit strategy. The company you invest in should know which one they’re headed toward by the time you go on board, so you can help them make decisions to get there.
Where to find angel investment opportunities
You might already be connected to startup business owners, in which case, you might be able to become an angel investor just by asking. A lot of business owners would be thrilled to have your experience (and money) on board as they work on growing their business.
If you want to stray outside of businesses you already know, or you just want to see what else is out there, then consider looking at businesses on an investment platform like CapitalRaisingClub.com. You can create a listing to attract businesses that cater to your specific interests and areas of expertise so you can invest in companies you believe in and that have the potential to give you a solid ROI within a few years.
You can also look for a local angel group. Angel groups have several members, each with their own specific niche of expertise. Because angel investors get lots of pitches, they might be able to clue you in to business investment opportunities that you wouldn’t otherwise know about.