How to Invest in Startups

Startup

The world of investing is changing. The year 2020 and 2021 has been explosive with the emergence of retail investors, meme stocks, and other news in the public markets.

U.S. Equity Indices have reached all-time highs. As of the close of November 26th despite recent volatility the S&P 500 is at 4,594.62, The Dow is at 34,899.34, and the NASDAQ is at 15,491.66. These are still historic levels.

However, as the market continues to rally, prospective returns decrease, and the ratio of risk and return begins to inflect. You will now be compensated less for any additional risk-taking.

Smart money managers are seeing this as now more hedge funds and other large institutional investors move to alternative investments for higher yields. One that has come to prominence as of late is venture capital. Today we will discuss how even retail investors can get some exposure to this area of finance and why you should try to invest in startups.

The Market is Expensive, Relatively Speaking

A lot of stocks are trading at all-time highs. For example, the average P/E ratio for the S&P 500 is 15.67, currently, its trailing P/E is 25.31 as of October 2021. Its forward P/E is around 22.

With the pandemic still raging on and economic growth muted many assets at their current valuations may be too high for many investors. Diversifying and finding undervalued assets is what is driving the push out of public markets and investing in companies earlier.

Zacks.com tells us, “A new venture can earn returns as high as 700 percent or have a negative return. According to the National Bureau of Economic Research, the average return is 25 percent.”

Investors want the highest return they can get for the risk they are taking. Startups can fail but with the right, due diligence and expertise they can survive and thrive with equity investors.

 

How Can Retail Investors Get Involved?

By law and SEC regulation here in the U.S. only accredited investors can get involved in venture capital and other forms of investments. 

However, there is still a way for those who won’t qualify as accredited investors to invest in startups. It is called crowdfunding and it has grown a lot in popularity over the last few years.

I recommend following this method until you are able to qualify as an accredited investor in the interim to network and gain experience with dealing with startups and other venture capitalists. Everyone starts from somewhere and gets involved as soon as you can pay dividends.

Doing Your Due Diligence

As with any investment, conducting your own independent research as well as entertaining discussions and gaining insights from those more knowledgeable than you are advisable.

Reading a company’s term sheet, audited financials, cap table, researching the founders, understanding the TAM (total addressable market), and so on is crucial.

Usually, startups aren’t very profitable (if they are at all) so it’s vital that you invest knowing this and the risks involved.

A good book I recommend reading is Venture Deals, it helps beginners and even seasoned veterans brush up on all things venture capital.

 

Pulling It All Together

This is a basic introduction to startup investing for retail investors. I think it is important to diversify and start getting involved with investing in different asset classes.

Venture Capital is exciting as it is risky, but it is the best place to meet entrepreneurs, visionaries, and innovators.

Timing is everything in investing because it can determine your ROI, but in terms of venture capital, it will help give you a head start in improving the world or meeting the needs or a prevailing issue.

Especially if you provide capital to a company that needs to bridge the gap to bring a revolutionary product or service to the marketplace.


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