Investing in startup companies is a bit like getting on a rocket before it launches. You could be part of the journey into space and make a big return on investment. But there’s also a real chance that something might go wrong, and you end up with an aborted mission. It’s both exciting and risky.
Invest in startups in three main ways:
Rather than investing directly in startup companies, you could consider investing in a small companies fund or a venture capital ETF (exchange-traded fund) through your workplace retirement plan or individual share trading account. You’ll still get exposure to small companies at the beginning of their growth cycle, but your investment will be diversified among many companies. The fund manager uses their expertise to research the best small companies to invest in so you won’t have to.
A startup is a young company in the initial stages of business. At this stage, the business owners may be testing their ideas and developing their product as they attempt to grow the business. Many new businesses don’t make a profit for a few years. As many as 20% of new businesses fail within the first year of opening, while only 25% make it to 15 years or more.(2)
Startups are often short of money as they have high costs and can find it difficult to raise cheap financing. They often grow and expand by getting several funding rounds, including investments from friends, family, venture capitalists and other investors.
Startups go through many stages, including pre-seed stage, seed stage, growth stage, expansion phase and exit phase.
The pre-seed phase is usually when friends and family invest, whereas the seed phase is when founders try to get outside investment from venture capitalists or angel investors.
The growth stage and expansion stage is when the business is growing quickly. The exit phase is when the owners are planning to sell the business or offer shares on the stock exchange as an initial public offering or IPO.
No. Startups are businesses at a very early stage and are funded by the founders, close family or venture capitalists. Sometimes, members of the public invest in startups through a crowdfunding website.
An IPO is a specific event where the company first offers shares to the public in a new stock issuance.
It’s usually at least a few years before a startup is ready to launch onto the stock market as an IPO.
Share trading platforms and brokers don’t usually offer startup stocks as they are not listed on the stock exchange. You’ll need to use a specialist crowdfunding platform to search for and invest in startups.
The amount you can invest in startups depends on whether you’re an accredited investor. While all investors can participate in early capital raises under Regulation Crowdfunding, non-accredited investors are limited to how much they can invest during any 12-month period. It depends on your net worth and annual income.
| Annual income | Net worth | Calculation | 12-month limit |
|---|---|---|---|
| $30,000 | $40,000 | Greater of $2,500 or 5% of $40,000 ($2,000) | $2,500 |
| $150,000 | $80,000 | Greater of $2,500 or 5% of $150,000 ($7,500) | $7,500 |
| $150,000 | $124,000 | 10% of $150,000 ($15,000) | $15,000 |
| $124,000 | $900,000 | 10% of $900,000 ($90,000) | $90,000 |
Source: Updated Investor Bulletin: Regulation Crowdfunding for Investors(3)
When you invest in a startup via a crowdfunding site, you’ll have a contract with the company you invest in.
There are different ways to invest, including lending to the startup company. The main types are as follows:
Startups don’t usually pay dividends to investors because they’re busy reinvesting all their profits into the business. Companies that pay dividends are usually stable, well-established businesses.
Startups have huge growth potential as they’re just at the beginning of their growth cycle. In contrast, large-cap stocks are far less risky, but there’s also less room for exponential growth.
Some of the world’s most famous companies, like Amazon, Apple and Meta (Facebook), were once startup companies in the beginning. If you’d got in and invested in the early days, you’d have made a serious fortune. But for every successful company, there are many others that fade away into oblivion. Picking the companies that will be successful is very hard for ordinary investors.
What Matt thinks about investing in startups
Startup investing can be lucrative, but it requires patience, as fledgling companies need time to grow and, hopefully, prosper. But, given their high failure rate, investing in startups is inherently risky. Experts recommend investing no more than 5–10% of your portfolio in risky assets like these.
— Matt Miczulski, Editor, Investments.
If you want to invest in startups, it’s important to do your research. Think about the product and ask yourself the following questions: How unique is it? How good is the marketing? What are the competitors, and how big is the market? How knowledgeable and committed is the founder?
Also, think about your personal circumstances. If you’re struggling to pay down debt or hit your savings targets, you probably can’t afford to take a big risk. If you haven’t yet started saving for retirement or don’t have any savings, it’s usually a good idea to get started on these first before investing in something risky like startup companies.
Startup investing is very risky and isn’t for everyone. But with big risks sometimes comes the possibility of big rewards. Here are some of the main pros and cons of investing in a startup company.
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