Why investing in startups can be a bad idea

why-invest-startups rocket launch

The “average Joe” wants to invest in startups because he knows he can become a millionaire with a limited investment

Is that true?

Sure, it is. But..


At the end of this article, you will be able to decide if startup investing is good for you and how to do it properly.

Startup investing is potentially one of the most lucrative investing activity and it is also a rather recent thing.

Let’s find out if startup investing can be either terrible or terrific.

Benefits of startup investing:

  • Potentially extremely lucrative
  • Very low maintenance needed
  • Supporting great ideas is fun
  • Jobs and wealth creation with our money
  • Isolating from market volatility by diversification
  • You can get a reputation if investing in the right companies at the right time

Downsides of startup investing:

  • Tremendous risk
  • Almost zero liquidity
  • Hard to get the right information on time
  • In some countries, you will not be allowed to invest as an ordinary investor

What the funk is a startup

A startup is a newborn company run by one or more entrepreneurs.

startup-investors

The goal of a startup is normally to develop a unique/innovative service or product and bring it to market in order to scale it.

The typical startup gets the initial funding from the founders themselves.

In most cases the founders will:

  1. Test the idea on the market
  2. Collect the necessary data to make sure the project is viable
  3. Build a (..hyper-optimistic) sales pitch

With a credible project and a short but effective sales pitch, the founders go to search for fundings.

This can be achieved in different ways.

Startups normally go to “startup accelerators/incubators” to find support.

Sometimes they will have to face a lot of people willing to reap them off by offering services in exchange of ridiculous portions of equity. They will either resist and try different ways or give up.


What does it mean to “invest in startups”❓

Until recently, investing in startups was the prerogative of special funds and venture capitalists.

Due to new legislation, now the market is more open and what is now called “equity crowdfunding” is the most common way to do it.

With equity crowdfunding, we support the startup company in return for equity. To make it simple, we give our money and we become owners of a tiny slice of the company. If the company thrives, our investment will be a good one.

If the company folds we are very likely to lose 100% of the amount invested.


Should you invest in startup companies

I don’t know your financial situation and background, but I’d say NO.

Why?

There are a few big reasons for me to say that, even if I don’t know you, Reader.

Investing in business, and even better in new business is just fantastic but it is also difficult.

ordinary-joe-investor

I wonder how many “average Joe” can find the time and the knowledge to be able to find out if a startup company will succeed or not. Are you above average? Good for you.

Let’s be honest, most of us love the idea behind some business but we can’t really make sure the project will makes sense at market level.

startup-investing-ideas

  • Those in love with beers, will likely invest in micro-breweries.
  • Those in love with technology will choose some weird ultra-fast computer project.
  • Vegans are likely to support some new vegan burgers.
  • Animal lovers will end up to follow some revolutionary cancer cure for pets.

So, I love dogs therefore I invest in dogs’ health or something like that…

When you visit their website (e.g. Wefunder) you will be inevitably attracted by some special campaigns, so beware.

Is this a proper way to do a preliminary study of business viability? I don’t think so, but we are humans, and we are programmed to make mistakes and lose money investing.

Equity crowdfunding can be a beautiful and entertaining way to lose money, especially if we mix up things and we start to invest in what we like instead of what makes money.

There is nothing wrong to support an idea through financing a startup business. I just want to make clear that it is difficult to know wether that money will come back with interest or not (come back).


Equity crowdfunding, investing or gambling

Another problem is that it looks like gambling. Make it or break it.

I like to know wether if I am investing or gambling, and in this world the difference is not always so clear.

One more reason why ordinary people should think twice before investing in equity crowdfunding is that the chances to lose the invested sum are very high.

When an investment is so risky the right thing to do is to limit exposure. Doing so we also limit the potential benefits.

So, if I am not a large investor I will be wise not to invest more than 1-5% of my assets in startup business. The problem now is that with a very limited capital invested, even if I’d make a 10x or 20x result, the impact on my portfolio will still be limited.

Is it worth it anyway?

Well, it also depends on the time spared on the research and the setup, because time is money for many of us.

With startup investing most of the effort is in the initial phase, then things go rather out of our control.

Is it fun?

Absolutely yes!


How legal is investing in startups❓

Many countries have regulated equity crowdfunding because it can be “slightly illegal” to solicit investments from the general public out of the rules. The offer has to be analyzed from the regulatory offices before it is made public.

Even if startup crowdfunding can be equity-based, debt-based, profit-sharing or a mix of the three models, we will be normally offered equity.

In order to be allowed to invest in some specific crowdfunding we have to be “accredited investors“. Accredited investors are certified to have the knowledge and the possibility to invest in such high risk field.


List of famous startups

Examples of extremely successful startups are easy to find, but the chances to be one of their investors at a very early stage without privileged informations are low.

Would have you invested in Youtube or Instagram some time ago?

It’s hard to say.

Why?

Because “the next big thing” is already here and we just don’t know what is it.


Investment in startups is tax deductible

Yes, some countries provide huge fiscal advantages for “angel investors”.

If one is really determined to invest in startups, it is worth collecting the right data and make a sort of “business plan” with a smart tax advisor.


What means investing in startup equity

This is a bit complicated but necessary to know.

When we have “equity” we actually have a slice of a company.

The overall value of the company can change a lot and go from zero to “very much”. If we own a slice of it, our share will follow the company destiny.

Early stage startup are those who offer the highest growth potential and we can invest in two ways.

One is convertible security and one is an equity round. Convertible are normally the early stage of the earliest stage. When a company starts the first equity round is very likely to be on track or at list it has been already assessed in depth.

From now on things get more complicated with factors like dilution  and option pools. It is all clearly explained by FundersClub guide.

Unfortunately very few investors will go that far to understand exactly what happen in the successive rounds and how their situation will evolve.


Startup statistics💹

An infographic is better than 1000 words:


Recap

Startup investing is one of the most fascinating assets classes ever, but the risks involved are huge.

Another tremendous downside of startup investing is the lack of liquidity.

When I trade stocks on the market, I can get rid of my investment instantly, or almost. If I invest in direct loans (In some cases) I can have access to a rather liquid P2P market to exit almost instantly.

This is not the case with startups.

With startups, even successful ones, it can take years before I see my money again (if ever). On the other hand, in case of successful “rounds,” as they call it, every euro invested can become a tiny slice of a tremendously big cake.

English is the language of most tools. Investors must conduct a thorough preliminary research on the terms and conditions before investing or ask for help.

It is also important to study the business plans of the projects themselves before investing.

As you can see, there is not much passive income here, since each investment (done well) requires plenty of time and the skills to find the right tools and the right projects to focus on.

A more relaxed but very profitable way to invest in business ideas is through debt crowdfunding or business loans, but again, there is no free lunch, it can be dangerous.

There is a lot to know to make some informed startup investing, here is a good “Startup investing” FAQ section from Startupxplore:

How to safely invest in startup


Let’s get to the actionable stuff!

Best startup investing platforms

I’ve made a list of the most popular or advanced tools to invest in startup.

It is crucial to know the terms before investing and learn some technical jargon.


WeFunder, USA

Motto:

“Break the monopoly of the rich”

“Now everyone has the right to invest in what they love!”

wefunder-investing revenueland

Wefunder is a giant US-based crowdfunding. They say they want to break the monopoly of the rich, who used to be the only ones with the resources needed to invest in startups. But it’s a brave new world, and things have changed. Now everyone can do it even, even with just a few dollars – but make sure to pay attention to the quality of the business. On Wefunder, you can find a bit of everything. The projects with more critical mass may be the safest, but I’d avoid the word “safe” in this chapter.


Seedrs, UK

Motto:

“Buy into businesses you believe in and share in their success”

Beyond Crowdfunding

Seedrs is my favorite option from the bunch. The minimum investment is £10, and commission on profits is 7.5%. Ordinary investors are the target customer. Some past projects have been funded and have already skyrocketed towards global success. Seedrs is an excellent tool to start in the “angel investing world” because it is within the reach of most people. They also have a secondary market where you can sell your investment to exit the deal if you so choose. Low liquidity is one of the main issues in startup investing. There is currency risk if you invest in euros.


Crowdcube, UK

Motto:

“Inspiring investment”

Top performing pitches – 22/10/18

Investments start at 10£ and conditions are similar to other platforms. It is by far the biggest crowdfunding site in Europe, with 700.000 members. It is authorized and regulated by the Financial Conduct Authority. There is also currency risk if you invest in euros.


OurCrowd, Israel

Motto:

“Invest in the future”

ourcrowd-investing-revenueland

Only very high-profile projects are carried out here. I’ve had the opportunity to be in contact with them and my impression was very good. The downside is that investors have to prove they are “accredited investors” in order to participate. Minimum investment is $10,000. Like I said, only big opportunities.


Angel.co USA

Motto:

“Invest with proven angels”

angellist-investing-revenueland

This is also a wonderful tool, full of resources and brilliant ideas. They have raised capital for companies like Uber and dozens of other less famous startups that have been later acquired by Google and other web giants.

Unlike ordinary crowdfunding, where you usually support a project in exchange for predefined “perks”, these tools allow you to become real shareholders if the project takes off. Angel.co is also a jobs marketplace.

Other popular crowdfunding platforms where to find projects and startup rising money are: CircleUp, Seedinvest, Goteo, FundedByMe, Crowdcube, Fundable and LocalStake.


Effort required to invest in startups: High, one-off initial.

My danger level: Very dangerous🌶🌶🌶🌶+🌶


Now it’s your turn!

What is your experience in equity crowdfunding?

How is it going?

Write it in the comments!


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