Have you considered investing in early stage startups? But you don’t know how to do it? There are questions you need to think about: How much do you invest? Where do you find startups? How do you balance your portfolio? If you don’t know the answers to these questions, don’t worry, you are not alone.
There are many investors who want to become a business angel and invest in startups, but don’t know where to start. In this blog post, I will give some tips to get you going. But before I do, I would like to talk a little bit about the history of startup investing: where are we coming from, and where are we going, in the world of startup investing.
So where do we begin? Well, only a few years ago startup investing was only for a lucky few. There were basically two reasons why this form of investment was very rare. First reason: it was very costly to invest.
The transaction costs you had to make — by hiring a lawyer that would help you develop contracts, for example — were quite high. The cost and difficulty of putting together a transaction meant that it would only be worthwhile if you were able to invest > € 100k. That’s a big amount, especially when you have to build a portfolio of five to 10 companies with investments that big.
That meant Angel investment was only for the successful entrepreneurs, or for the former CEO’s and CFO’s of the world, who had a lot of money on their hands at the end of a career. But that was not the only problem: even when you have all the money in the world, where do you find good startups? It was quite difficult to find startups, even for enthusiastic investors. There just isn’t a single place where they all hang out. If you don’t see enough potential deals then it is difficult to build a good portfolio. Of course, at the same time, it was difficult for many good startups to find investors. On the whole, it is fair to say: this market didn’t work very well.
Nowadays these barriers have been reduced: there are online investment platforms that use standardized contracts and offer instant access to a range of companies. Because of this, Angel investing is now available to everyone. On these platforms interesting startups can be easily found: everyone comes together on the same website. Investing can start from as little as € 1,000, since transaction costs are negligible.
With a website like this, everyone can get passionate about investing in early stage startups. You can find yourself working alongside enthusiastic entrepreneurs who want their company to become the new Google or Facebook. Let’s face it: that’s pretty cool. Investors find that it gives a lot of energy to help early stage startups to reach their goals. You might say: we are in a golden age of startup investing.
Below I have some tips you might find useful. But there is one thing I would like to emphasize: Be careful when investing in startups. Although everyone can invest now: startup investing is not for everyone. You will find yourself dealing with complex financial products and highly risky investments; make sure you don’t invest money you can’t afford to lose.
Enough introduction: let’s now go on to the seven tips when dealing with startup investing.
1. Mentally write your investments off
Facts and figures on startup success and failures are flying around. Some say seven out of 10 fail, some say nine out of 10. Some say that startups in accelerators are less/more likely to fail, some say that startups who have blue in their logo have a much higher/ lower success rate than startups with red in their logo, and so on…
This market is still in its infancy, and putting together sensible statistics is quite challenging. However, I dare to conclude that the chance is higher that a startup will fail than that it will succeed. This means for investors that for any startup company they have a higher chance of losing their investment than making money.
Good returns on a startup portfolio come from getting a few big hits in your portfolio. And those hits could take a while to realize, and they are relatively rare. So the first advice anyone should give you: please only invest money that you can miss. You should be willing to mentally write off your investment when you start.
2. Learn to use the financial instruments that are designed for startup investing
People who are considering a startup investment are usually familiar with how normal shares and bonds work. However, in the world of startup investing there is a range of unique financial instruments, which you will need to learn how to use. In particular, convertibles are becoming the norm. Convertible equity or convertible loans have several advantages over regular shares or loans. Now pay attention to the next paragraph:
Basically, a convertible is a loan which accumulates interest over time, and is eventually converted into shares. The conversion happens at the so-called qualifying event: usually the first major equity…