If the popularity of ABC’s Shark Tank is any indication, Americans either want to start new businesses or invest in them. Either way, the thousands of dollars changing hands have people wondering what it actually takes to invest in a startup and how they can get involved. That doesn’t mean that everyone can, or should invest in a startup.
Since Title III of the Jobs Act went into effect, almost anyone can invest in a startup, as long as they have enough money in the bank not to go bankrupt doing it. Previously, to be eligible to invest, an individual had to have an income of more than $200,000 annually or have a net worth of more than $1 million to invest in private companies.
Now, however, even individuals that have an annual income of less than $100,000 per year can try their luck investing in new companies. There are limits, however, with those who earn less than $100,000 annually being able to invest only up to 5% or $2,000 of their annual income, while those that earn between $100,000 and $200,000 are allowed to invest up to 10%.
Even for individuals that meet the income requirements, investing in new companies is risky business. That’s because almost half of new businesses that are funded by investors from crowdfunding sites fail in the first four years.
That’s not to say that there aren’t success stories. There definitely are, and the rewards for someone lucky enough to invest in Instagram have exceeded expectations. It’s just worth noting that investing in startup companies is a lot like betting it all in a game of poker. Even the best players lose sometimes.
Most people have heard of crowdfunding, even if they don’t know exactly what it is or how to get involved. Crowdfunding wouldn’t really be possible without the internet. Crowdfunding platforms allow entrepreneurs to present their ideas and businesses to many people at once in an attempt to raise capital.
The money raised comes from many individuals so that million dollar sums can be raised in increments of $2,000 or less. This lets the company reach its funding goals, without having to rely on traditional venture capitalist firms or angel investors. It also lets individuals invest in projects and companies that they think are promising, on a more involved personal level.
Not all crowdfunding platforms provide a stake in the company or a financial return on investment. Some opportunities allow people to invest in a company in exchange for products, those solutions are great, but really equate more to advanced purchases than to investments.
A Quick Warning
Not all crowdfunding platforms are equal. Some have a significantly higher bar of entry than others for companies seeking funding, and the higher the bar to entry, the more likely the company is to be legitimate. For example, SeedInvest only selects 1% of the applicants that apply for funding. Where do the other 99% turn for funding? Likely to a platform with a lower standard.
The best platforms require audited financials and third-party valuations. They also explain whether investor money is put in a bank or in escrow, and have clear policies for solving any problems that arise. Finally, it’s important to choose a crowdfunding platform that has been around a while and is backed by venture capital itself. Those platforms have the financial ability to help investors if anything does go awry.
How does an investor realize a profit from an investment in a startup? There are several ways that produce viable profits. The first, and most lucrative, is when the business is acquired by another company. Investors can also realize a return if the startup goes public and the investor’s shares can be sold on the market. Finally, if the company starts paying dividends, investors will also see a return.
Investing in startups can be very exciting, and may even be lucrative for some, but the risks are high enough to give them strong consideration before diving in.