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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.
Investing in startups at a glance
Investing in early-stage companies can be exciting, and there’s the potential for big returns. But many startup companies fail, so it’s a very risky type of investment.
Because of the risk involved, for most people, it makes sense to only invest a small proportion of their total portfolio in startups.
Investments in startups can take several years to materialize, so it’s important to practice patience.
How to invest in startups
Invest in startups in three main ways:
Through crowdfunding platforms. Crowdfunding pools are often relatively small individual investments to fund projects. Companies interested in pursuing the crowdfunding financing method need to either register with the Securities and Exchange Commission (SEC) or meet an exception. Regulation Crowdfunding, adopted by the SEC in 2015, provides such an exception, allowing companies to offer and sell up to $5 million of their securities without having to register the offering with the SEC.(1) Regulation Crowdfunding lets anyone participate in early capital raising activities of startups. These crowdfunding platforms typically offer a modern, streamlined investing experience, and minimum investment requirements may be as low as $100.
Through friends and family. If someone you know is starting a business, you can become a supporter and invest directly with them.
Buy company stock after an initial public offering (IPO). Invest in the company’s stock if it goes public.
Are there any other options to invest in startups?
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.
What is a startup?
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.
The different stages of a startup
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.
Are startups the same as IPOs?
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.
Do brokers offer startup stocks?
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.
How much you can 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)
How to make money investing in startups
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:
Debt: You’ll receive interest in exchange for lending money to the startup company.
Equity: You’ll buy shares in the startup company. You’ll make money if you sell the shares later for a higher value, usually when the company floats on the stock exchange or is bought out by another company.
Convertible note: This is a type of debt that may convert to shares later on depending on certain conditions being met.
Do startups pay dividends?
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.
Why should I invest in startups?
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.
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.
Pros and cons of investing in startups
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.
Pros
Exciting: You could get the opportunity to be part of the next big thing.
Belief in the idea: You can feel part of a new project or company you believe in.
Potential for big gains: You could make a big profit if the business is successful.
Personal connections: You might have a friend with a startup company, and you want to invest to support them.
Cons
High risk: It’s estimated that as many as 90% of startups fail, so there is a big risk that you could lose all your money.
No dividends: Most startups don’t pay dividends, so you won’t get an immediate return on your investment.
A long wait: It’s hard to sell your shares, and you may have to wait until they’re ready to launch as an IPO to get any money back from your investment. You should expect your money to be tied up for at least three years, if not more.
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Yes, it is possible to invest in startups. Regular investors can invest in startups through any of the many startup investing platforms available today, including Fundrise, StartEngine and Wefunder.
Regular investors, whether accredited and non-accredited, can invest in startups online through platforms like Fundrise, StartEngine and Wefunder.
Invest in startup companies through startup investing platforms like Fundrise, StartEngine and Wefunder. Many of these platforms are open to non-accredited investors and don't require steep minimum investments to get started.
It can be good to invest in startups as you're getting in at an early stage when there's a big potential for share price growth.
However, investing in startups is extremely risky and not for the faint-hearted. You may wait a long time to see a return on your investment and there's the possibility you could lose your money if the company fails.
Investing in startups can be profitable as there is the potential for your investment to grow significantly in the future. However, expect an investing timeframe of several years.
You may need to wait until a startup company grows big enough to trade on the stock exchange before you can sell your investment. It all depends on the type of investment contract.
It's hard to predict the best startup company because it's difficult to tell which will be successful in the future. Many investors prefer to invest in businesses they know well and understand. That's because it's easier to assess if the product is likely to become popular and the business will be successful.
No, startup companies aren't listed on the stock exchange as they are in an early stage and are too difficult to value. Companies often list on the stock exchange through an IPO once they've grown to a certain size.
Alice Guy is a Suffolk-based finance writer, a busy mum of 4 older kids and a self-confessed personal finance geek. She trained as a chartered accountant with KPMG London before working for Tesco Plc as a business analyst. She loves to write about budgeting, saving, investing and building wealth. See full bio
Matt Miczulski is an investments editor at Finder. With over 450 bylines, Matt dissects and reviews brokers and investing platforms to expose perks and pain points, explores investment products and concepts and covers market news, making investing more accessible and helping readers to make informed financial decisions.
Before joining Finder in 2021, Matt covered everything from finance news and banking to debt and travel for FinanceBuzz. His expertise and analysis on investing and other financial topics has been featured on CBS, MSN, Best Company and Consolidated Credit, among others. Matt holds a BA in history from William Paterson University. See full bio
Matt's expertise
Matt has written 188 Finder guides across topics including:
A deep dive into the highlights and limitations of Robinhood.
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