If you’ve ever thought about finding a way to invest in a private company in a high risk/high reward manner, investing in a startup company could be a great choice. When you invest in a new, private company, you’re not only giving yourself the potential for a fantastic return, but you’re also investing in other peoples’ futures. For those of us daring enough to take the plunge, adding startup investments can be a great way to balance your portfolio.
But before you dive head first into this somewhat volatile investment world, be sure to consider the following tips and tricks for giving yourself the best odds of a great return on your investment:
Do Your Homework
Not only should you have a keen awareness of the market the startup is operating in, but you should also have as much understanding about the business, its owners, and the competitive landscape as possible. Gather information from public records, speak to other people, even interview the management if you’re able to set a meeting.
As you gather your information, keep a keen awareness for the scalability of the company–do you see this product or idea or service being something that can effectively make money while serving the intended demographic?
Diversify!
First, remember that the investments you make in startups should be viewed as long-term investments. Second, adhere to the golden rule of investing and diversify your options. In doing so, you’ll minimize your overall risk and increase your chances of reaping great rewards–especially if one of the companies you choose to invest in ends up going public. If you need some professional advice about which types of private businesses to choose for investing in, take a look at the CSS Partners website.
Dig into the Financials
As an investor in a startup, you want to have the full picture of the company’s financial situation. One of the most important parts of this information gathering is to understand the burn rate of the company–what are they doing with their money? What potential benefits are they buying with that cash? Do the choices made by the management team make sense to you?
Remember that it will be very difficult for a company to be able to precisely project what will happen in the coming years but that doesn’t mean you shouldn’t press to see a plan for what they anticipate. Drill into the financials and projections–can you see a future in this company and financial strategy?
Check the Paperwork
A full review of the company’s documents should also take place prior to making your investment decision. View the articles of incorporation. Are there bylaws you can view? Term sheets? Read everything you can gain access to and read it again. Check all the fine print, especially how the potential payouts will be structured–what are you really getting in return for the money you’re investing?
Follow Your Gut
At the end of the day, follow your intuition. If something doesn’t seem right, don’t be afraid to walk away. And, as always, don’t invest money you can’t afford to lose!
Have you ever invested in a startup?
The only startup I've invested in was to invest my annual bonuses in shares of the private company I worked for. All other money (retirement and taxable accounts) was invested in low-cost index funds. I got lucky when the company was eventually bought by a larger firm. I do not plan to ever invest in another startup.
My recent post Listed in the Carnival of Financial Planning
Never invested in a startup. Those are hard to come by in my neck of the woods. With startups it like you stated – more of a gut feeling. You never know where they are going to go you can only look at how they are spending their money and the team and leadership they have. The product has to be worthy first and foremost.