How to invest in startups: is it a good investment?

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 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 billions – to smaller but equally successful start-ups, such as Brewdog, even a modest start-up investment can be a lucrative opportunity.  

However, these are the big success stories. Only 39% of new businesses survive for five years, meaning that while the opportunity to make money is there, investing in start-ups remains a high-risk venture. 

How do you invest in a start-up? 

There are a number of ways to invest in start-ups. Not everyone will have the means to invest huge sums like angel investors, but there are ways for smaller investors to get involved.

Here are a number of options:

• Crowdfunding: 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.

• Bonds: 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 company’s success.

• Become an angel investor: Many wealthy entrepreneurs or experienced business people will seek out start-ups to invest in. In return for your investment, you’ll normally get an equity stake in the business - typically 10% to 25%. In addition to money, angel investors typically offer mentoring, support and contacts to the businesses they invest in.

When is the right time to invest in a start-up? 

Deciding when to invest is a challenge almost all investors face. To maximise your profits, you should look to invest in a promising business as early as possible.

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 any guarantees the business will turn a profit.

With many investors operating on budgets or with a set amount of disposable income, jumping the gun can be risky. But invest too late and you may miss 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 risk appetite. 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.

Seek financial advice

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.   

If you found this article helpful, you might also find our articles on the best investing and trading apps and the top mining companies to invest in informative, too.