Startup investing was a restricted activity up until recently. First, regulators put restrictions in place to protect investors from complicated investments and, worse, frauds. While these protections were good intentions, investors soon realized the importance of a fair system. This is where equity crowdfunding comes in.
Platforms like Wefunder or Republic let anyone invest as little as $10 into startups they support and believe will become significant. It’s a win/win for everyone involved. Investors now have simple access to thousands of promising startups while entrepreneurs have a new channel to raise capital. Startup investing is riskier than an S&P500 ETF, but it offers investors benefits that stock-market investment cannot. Here are three.
One investor might invest in Netflix because they believe it will continue to dominate the streaming world, and its stock market will rise. That’s fine. However, the money invested in Netflix isn’t going to a bank account for financing The Notebook 2. When investors invest in a startup via an equity crowdfunding platform, the money directly supports its mission.
Many of these startups seek to benefit humanity in some way. Agora is one example of a small business that aims to compete with online giants. It makes local shops’ inventory easily searchable online so consumers can find it and make purchases. Leah Labs is an innovative biotech company that develops treatments for currently incurable diseases. Investors have the option to find companies that are aligned with their values and passions and contribute directly to those efforts. This way of investing can provide more than financial benefits.
High risk, high reward
Investing as a startup investor is riskier than investing as a blue-chip stock. A 6-month-old startup that burns $100,000 per month is a great way to lose a farm. However, as is often true, the potential for significant wins outweighs the risk. Let me give you an example: It has been reported as high as 6,000 times. This is Garry Tan’s return from his Coinbase investment of $300,000 in 2012. At IPO, it was worth around $2 billion.
Although most won’t see such a huge return, it can motivate small-scale startups with big goals. This is why investors should aim to make one dollar turn into $50 or $500. Or, if you’re Tan, 6,000 dollars (before dilution).
Although it requires a different set to evaluate startup investments compared to public equity, many lessons can be learned from both asset classes. One difference between startups and stock-market investing is that investors need to envision what could work well.
Liquidity – or lack thereof
The last one could be spun in several ways. But we’ll stick to the optimists’ point of view. Shares that are purchased from an equity crowdfunding platform can be highly volatile. The stakes are highly illiquid, meaning that investors will not convert them to cash in the coming months, years, or longer. Startup investors must see the company go through liquidation to get their cash back. This could happen through an IPO, acquisition, or a less exciting outcome such as a wind-down and merger with another startup.
First, this proves that individuals should not invest more than they can afford to lose. Even if they see some return, it won’t be until someone else makes that decision.
This is a good thing. Investors are prevented from making emotional or rash investments, and the illiquidity allows for investment to reach its full potential. Over-trading, which is buying and selling based only on short-term fluctuations that do not materially change the company’s course, is one of the most common mistakes made by stock-market investors.
This is how it works: An investor may have invested $1,000 in Amazon stock in January 2015. It was trading between $300 to $400 per share. In August 2018, the stock was trading at $1,800 per share. The stock was then pulled back 20 percent. There were undoubtedly people who sold stock at this point due to adverse price action or believing that the significant gains were over. The stock traded at close to $3,500 today. It did recover. That is the difference between making five and ten times your money, which can profoundly impact your life.
The funds that an investor has invested in a startup are secured. This means that the investor must take a long-term view, which is almost always better than short-term trading.
A new horizon
Recent regulatory changes and technological advancements have made these asset classes available to retail investors. It is worth your time to explore these possibilities. CAPONE recently published a list of dozens of exciting equity crowdfunding campaigns on Wefunder. It should not be used to replace stocks or bonds. However, it may justify a small portion of an average investor’s portfolio for alternative assets such as startups. A small part of your portfolio could produce greater returns than the rest.