Investing in startup companies is a bit like getting on a rocket before it launches. You could be part of the journey into outer space and make a big return on investment. But there’s also a real chance that something might go wrong and end up with an aborted mission. It’s risky and exciting.
What is a startup company and how can you invest in startups? Let’s dive in and find out.
A startup is a new company that’s just been founded. At the beginning, the business owners try to test their ideas and grow the business and many new businesses don’t make a profit for a few years.
Startups are often short of money as they have high costs and can find it difficult to raise cheap finance. They often grow and expand through getting several rounds of funding, 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 will 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 float on the stock exchange as an initial public offering or IPO.
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.
It’s usually at least a few years before they’re ready to launch onto the stock market as an IPO.
Startups don’t usually pay dividends to investors because they’re busy reinvesting all their profits back into the business.
Instead, if you invest in startups, you’ll have to wait until the business is bought out, or floats on the stock market through an IPO to be able to sell your shares.
Share dealing websites 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 website to search for and invest in startups.
In the UK, there are no rules about what you can invest in a startup. But it’s sensible to weigh up your overall investment strategy and not commit what you can’t afford to lose as startup investment is very risky.
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 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 Facebook (now called Meta), were 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.
If a startup company is successful you could get a great return on your investment. However, if the business fails you could lose all your money.
If you want to invest in startups, it’s important to do your research. Have a 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 have a think about your personal circumstances. If you’re struggling to pay down debt or hit your savings targets then you probably can’t afford to take a big risk. If you haven’t yet started a pension scheme or you 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.
Ordinary investors can invest in startups through a crowdfunding website. Crowdfunding works by hundreds of individuals investing small amounts of money. They can contribute small amounts of as little as £10, although some platforms have a £1,000 minimum investment.
Startup businesses have to apply to the crowdfunding website and get approval before being listed for investors as a possible investment.
Once you’ve subscribed to the crowdfunding website, you can search through all the different businesses and projects available for investment. You’ll be able to invest using a credit or debit card and you can invest with small amounts, depending on the rules of the crowdfunding website.
Rather than investing directly in startup companies, you could consider investing in a small companies fund or a venture capital ETF through your pension scheme or share dealing account. You’ll still get exposure to small companies at the beginning of their growth cycle, but your investment will be diversified between many companies. The fund manager will use their expertise to research the best small companies to invest in so you won’t have to.
Think of startup investing as a bit like a cherry on the top of your ordinary investments. Some experts recommend only investing a maximum of 5% of your total portfolio in super risky assets like startup companies.
Like any investing, take financial advice if you’re not sure where to invest. And remember that it’s particularly important with risky investments to only invest what you can afford to lose.
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.
Investing in startup companies can be fun and there’s the potential for big returns. However, many startup companies fail so it’s a very risky type of investing. For most people, it makes sense to only invest a small proportion of their total investment wealth in startup businesses. It’s important to think about diversifying your portfolio and investing in a wide range of shares and other assets.
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