Are you entrepreneurial, educated about the startup scene, and ready to invest? Startup equity may be an ideal choice for your next investment due to the capacity for expansion and development. Explore everything you need to know about investing big in small startups.
The pros of startup equity
The first reason angels become attracted to equity startup is often for the pure thrill of the experience. When you invest in an established corporation, you do the paperwork, and then you sit back and hope. However, that movement isn’t the case with investing with a startup. A startup demands attention, focus, and commitment.
Depending on how much money you have to invest with a startup, you could well have a stake in the company’s direction and its overall mission. You can keep tabs on its progress, and you may be called upon for input. Even though you’re not directing its mission and you don’t hold specific responsibilities, you’re a part of the action. You can play a role in its decisions.
Another aspect brings a thrill to the experience: Startup entrepreneurs are some of the most motivated and hard-working people you’ll find. It’s no wonder they need beer on tap or ping pong tables in their lobbies: Some workers are so single-mindedly focused that they can’t or won’t take a break. This kind of energy and enthusiasm is contagious and simply pleasurable. And some startup employees and CEOs, in the likes of Silicon Valley personnel, have the attributes of pure genius. Since so much is at stake for everyone in the company—both in terms of equity like yours and personal ties—employees are bound to do their best.
Finally, the biggest pro to equity startup is the most obvious: If you’re lucky and your gut is correct, you may cash in and eventually retrieve much more than you had invested in the first place. Not only can you make money in the long run, but you’ll also walk away with a good sense of having taken part in the process. This pleasure can lead you to come back for more opportunities in the future, and you’ll build your long-term investment experience.
The cons of startup equity
While enthusiasm, hard work, and great intelligence can lead to advancement, the reality is that some startups estimate their worth as higher than a proper valuation would claim. This estimate is not always their fault: Entrepreneurs have the tendency to view potential as actual, and they may estimate their net worth as more than their immediate performance can speak to. As the investor, be realistic and factual about what the startup is generating now. Don’t rely on potential leads to gain an accurate estimate.
The added concern here is that investors can find difficulty gaining this kind of objective information. You have to be well-versed in the field and know how to discuss the financial stakes, budgets, and assets openly. As an investor, you must know your rights and gain exposure to how information gets translated and communicated to make secure decisions about your purchase.
The other large disadvantage when you invest in startups for equity is obvious: You have risks involved. Of course, the largest risk is that you may lose your principal altogether. However, you can also simply lose the return on your principal, which can also be a huge loss. Or, you may experience a delayed return in the case that the startup needs to cash out quickly and can’t repay you at once. Lastly, you run a liquidity risk. In case of hard times, you may have difficulty transferring your equity or selling it to another investor.
Despite the pros and cons, gaining startup equity is a challenging opportunity for investors to get involved in new businesses and to both build and take advantage of new opportunities.
Invest in startups for equity
Now that you know the pros and cons in investing in a startup, how can you go about it? If you’re a beginner, discover the following words of wisdom.
Diversify
You can optimistically believe that every startup is going to make it big—or at least big enough that one will keep on keeping on for years to come. Indeed, the nature of the startup world can make you feel that kind of hope. As mentioned, startups are often full of vibrant energy and candid intelligence. These elements, coupled with passion, can definitely be an asset during the road to success. However, not all startups excel; such is the nature of economics and chance.
Therefore, you want to diversify your portfolio to create a more secure situation. If you’re ready to invest in startups for equity, being in a financial position to diversify, too, is excellent. This diversification can pave the way to benefits for you and your multiple newfound partners.
By investing across multiple companies, you also acknowledges that the keys to success are still, in many ways, mysterious. Sometimes, the people and companies we think are not bound to be successful turn out being stars, while those that seem to know what they’re doing flunk out over time. Don’t gamble on knowing where the paths will lead. Be optimistic yet conservative by spreading your angelic wings across multiple avenues.
Research
The good news is that when you’re building startup equity, you have plenty of leads from which to choose. You can go larger or smaller, intimate or conservative, high-profile or beginner. You can feel free to select from among a varying amount of subjects and businesses in the tech field. However, the key to this differentiation should be your own education. Try to understand the company’s inner workings, not only from your view, but from the startup viewpoint as well. Seek to name what they stand to gain from you.
Make a list of the top 10 companies that interest you and do your homework on each one. Who founded the company? What is the owner’s education and experience? Where have the owners and managers worked before? Have they had past or recent successes? Do they get along with other companies in their field? Do they have adequate financing? Would an expert invest with them? How do the companies use their finances? How much do they charge for their products? What is their game plan?
By doing your homework, you’re protecting yourself from making choices that are simply too risky. Nothing is wrong with being optimistic and taking a chance if you have both security and knowledge to do so, but make sure your decision is not a naive one.
Prepare
As with any financial investment you make, once you come close to signing off, you need to pay special attention to the details. The first detail is natural and obvious: If the startup fails, can you manage your losses? Is the possible loss worth the risk? Startups can be promising, but they can’t truly promise anything.
Once you’ve decided that investment is a potentially good venture for you, then in the case of startups, you must take care of many details to prepare for the deal. Once you do the research about the company, you’ll want to take your time to review all the legal documents. Find a reliable and trustworthy lawyer who can take the time to explain caveats to you personally. Articles of incorporation, bylaws, investor agreements, subscription agreements, and term sheets are all relevant and important to understand.
Next, be sure that you understand how the company gets organized and where you fit in. What is your newfound role in that system? Then, make sure you comprehend the agreement you’re making in terms of what you’ll own and according to the money you’re offering. When and how can you cash, transfer, or sell your ownership? These factors are all integral points to consider.
Are you ready to invest in startup equity? If you’re in the financial position to do so, then that’s great news. Both you and your newfound partners may truly benefit. But first, do yourself a favor: Think hard about both the pros and cons of startup equity. When you’re ready to get started, be sure to do your homework, invest broadly, and take care of all the education on your end. Keep tabs on how your equity is doing, and enjoy the ride to success.
