Investing in a successful start-up can help you take significant steps towards financial independence. But not every start-up will be a success.
While you could end up with some impressive profits, you could also end up losing your money.
Here’s what you need to know about investing in start-ups and whether it’s the right for you.
Why invest in start-ups?
Finding the right start-up is an investor’s dream. For what will often only be a small initial investment, a successful start-up business could quickly grow to become a highly profitable enterprise, meaning that as an early investor, you would earn big profits.
From the early backers of tech giants such as Facebook, Google and Amazon – whose profits are today in the multi-millions – to smaller, but equally successful start-ups, such as Brewdog and Bulb, even a modest start-up investment can prove to be a very lucrative opportunity.
But not every start-up will achieve success. Only 39% of new businesses survive for five years, meaning that while the opportunity to make money is there, you’re also risking your money at a time when many businesses are facing challenging circumstances.
How do you invest in a start-up?
Investing isn’t the closed shop it used to be. While some of the more traditional ways of investing in a business may still apply, for example buying shares in an initial public offering (IPO), crowdfunding has become a popular alternative for people looking to invest small amounts in new businesses.
If you’re looking for a promising start-up business to get behind, consider what method most appeals to you:
Crowdfunding has opened up small business investing to the public. Platforms like Crowdfunder allow people to contribute as little or as much money as they would like towards a small business. While not all crowdfunding campaigns will reach their goals, some have gone on to be extremely successful. For example, the brewing business Brewdog has built its success thanks to thousands of crowdfunders who first bought into it.
An initial public offering (IPO) is where a private company lets members of the public buy shares in a business for the first time, in return for a share of the profits in the future. IPOs can be extremely lucrative ways to fund a new business, with shareholders in businesses like Amazon and Intel earning millions of dollars’ worth of profit on their holdings. If you had bought $1000 worth of shares during Amazon’s IPO in 2011, you would today have profits over $17.6 million – an increase of over 1666 percent.
Bonds allow you to invest in a business, with the promise of receiving that amount plus interest back in the future. It’s a less common way to finance a small start-up as bonds are time-limited, so once your profits have been delivered, you would need to buy more bonds to have an ongoing share of the business’s success.
When is the right time to invest in a start-up?
But at the same time, invest too soon and your money will likely go towards footing some of the start-up’s initial costs without guaranteeing it will turn a profit.
With many investors operating on budgets or with a set amount of disposable income, jumping the gun can be too risky.
At the same time, invest too late and you’ll have missed out on the larger returns. Other investors, potentially with a lot more money, may have invested before you, so while it could be less risky as the business is already on the right path, you could have achieved better earnings by getting in earlier.
This trade-off comes down to your individual circumstances and your appetite for risk. If you’re operating on a tighter budget, it’s worth being more cautious with your money, whereas if you have more money to spend, you could take on more risk and hope for larger profits further down the line.
Dos and don’ts for investing in start-ups
The key to investing is to be as safe as possible. Not every start-up can succeed, so investing safely is key.
Here is our advice for investing in start-ups:
Do your due diligence: this means looking in depth at the underlying structure of a business. What funding has a business already received? Have they met repayments or are they on course to? Can the business grow in its market and challenge competitors?
Do meet the team: this lets you find out more about the brains behind the business. Is the commitment there to build a long-term project? Do they have a past of helping businesses succeed?
Do take your time: don’t be rushed into taking a decision and don’t just plan for the short term. Some start-ups can take a few years to grow before they start to yield any results but this doesn’t make them any less prudent investments.
Don’t expect your money back: Whether a start-up needs your money to grow for a few years or outright fails, you should only ever invest money that you’re comfortable losing. If the loss of your investment would have a negative or significant impact on your life, consider whether you should be risking your money at all.
Don’t take one person’s word for it: Ask your connections, investors or start-up owners themselves whether a business’ idea and operating model sounds feasible. Don’t just take a prospective business’s word for it.
Investing in a start-up business can yield lucrative earnings, but it can also lead to you losing your money.
If you’re looking to take steps towards your financial independence, speak to a financial adviser who can help you use your money wisely.
Find an adviser on Unbiased.