How to Consider Startups as an Alternative Investment Strategy
Many investors think their options are limited to stocks and bonds, either directly or through a 401(k) or IRA. There are, however, many alternative investment options available.
For some investors, startups are a good choice. Startups feature hungry entrepreneurs looking to turn an idea into a profitable business.
Startups are an attractive consideration for alternative investment options. Investors, however, should do their homework and invest cautiously. Knowing what to look for in an investment and what questions to ask are important steps. Learning how to protect your investment can make startups an attractive choice for investing your money.
Your risk tolerance plays an important role
Startups may seem like a tantalizing possibility. The Silicon Valley giants all started out as small companies short of garages and dormitories. It was the investors who believed in the ideas and gave these fledgling companies a boost.
Yet for every Apple, Microsoft and Facebook, there are hundreds of other companies that have failed.
There is a high risk, high reward element to alternative investments, especially startups. Federal regulations have relaxed when it comes to investing in these companies. However, the Securities and Exchange Commission still imposes certain restrictions on the amount investors can invest over a 12-month period.
If your annual income or net worth is less than $107,000, SEC guidelines allow you to invest up to $2,200 or 5% of the lesser of your net worth or annual income.
If it’s over $107,000, you can invest up to 10% of your annual income or net worth, whichever is lower, up to $107,000.
Alternative names for seed investing include venture capital and angel investing. For personal investors, the concept is enticing. Help an ambitious young entrepreneur overcome the hurdle of funding and try his luck. Just be aware that many companies don’t.
Know how much you are willing to risk before getting involved in seed investing.
Smart investors consider startups like the other investment categories. Instead of putting all their funds into a single asset, savvy investors diversify their portfolios. Taking the same approach with startups is a good choice.
Develop your investment strategy
Build an investment strategy before embarking on alternative investments. Start by deciding how much you are going to invest and how many trades you are going to invest in. Having 15-20 investments gives your startup portfolio the diversity to protect the financial commitment.
Do you want to give equal weight to all your start-up investments? It is an approach to diversification. Another is to give yourself the leeway to invest more in businesses you strongly believe in. Either way, it’s best to know you plan to allocate your funds before you invest.
What do you want to invest in? Think about the types of businesses you want to engage in. Are you looking to support an idea that a great team is working on? Would you rather invest in a more mature startup that offers a functional product or service and, perhaps, revenue?
You can also specialize in one industry and spread your investments in that niche. You may want a combination of investment stages on your first foray.
Find your sources of offers
With the stock market, investors have access to all publicly traded stocks available. This is not the case with startups. Finding companies seeking funding is not as straightforward as alternative investments. Access to startups requires a bit of groundwork.
Various crowdfunding platforms provide access to startups looking for angel investors. The platforms offer different levels of access and offer a minimum of due diligence. These sources provide access to multiple companies across all industries, while others focus on a niche investment area.
Joining an angel investment club is another option. Here you will find like-minded investors eager to identify strong potential investments. They can also be a good sounding board for making decisions about your investments or hunches about businesses. Often, members pool research responsibilities and decide where to invest their funds.
Understanding financial instruments
Investments in startups come with various investment options. Convertible notes are a popular investment instrument today. Convertible shares are essentially a loan that earns interest over time. Eventually, the note is converted into shares.
The conversion is usually tied to a major event, such as the first major funding round. Convertible investors get shares at the price offered for the financing round, for example.
For investors, the convertible approach can mean a substantial payoff when the company gets the attention it deserves. For startups, these agreements allow them to work and invest the money brought in without worrying about repaying the debt. They are a simple way to raise funds while fine-tuning the business.
Other options include debt financing, where you lend the business money. The contract pays a fixed or variable return, depending on the performance of the business.
If you invest in late-stage startups, you may be able to buy shares, like in a public company. You may need to hold onto the shares until the company goes public.
How to research startups
Reviewing business plans and financial data is an important factor to use in deciding whether or not to invest. Also consider whether you have expertise in the startup field, allowing you to apply this knowledge to your decisions.
If you meet the team, are they passionate about their work and see its success? Do they have the expertise to lead or do they learn as they build?
Also, get an idea of the market size. A large and growing market is essential for startups to succeed. Finally, ask yourself if now is the time for the idea – why this product or service right now?
Startups can be an exciting way to invest and see the possibilities. Learning about companies and being part of their success has its unique rewards.