You can find a wagon and a small cart of compelling reasons that will be undeniable, why investments in startups should be made without hesitation..But… On this path, on both sides, there are many crosses on the graves of unfulfilled hopes. Why? Because there are various “pitfalls” in the means to do this, most of the times risky.
How to invest in startups
A startup is a commercial project that is often invested in through venture capital (VC) funds, either private or public. If it is listed on a stock exchange, its shares can be purchased directly through online brokers. In addition, it is possible to invest as a crowd investor.
As it has already become clear, there are various ways to invest your hard-earned money in them. However, not all of them will suit you for one reason or another, having certain advantages and disadvantages. Next, we will do our best to explain the mechanism of such investments, from A to Z, and you need to study everything like “Our Father…”.
Investing in startups: advantages and disadvantages
Why invest?
Perhaps the main and most “tasty” reason is the opportunity to get very, very high profits. What is it about? For example, Paypal was bought for $1.5 billion, and WhatsApp for $19 billion. Those lucky people who owned even a little less than 0.5 percent of the company’s shares became rich. Do you need a calculator to calculate their income, or do you do it yourself?
Since many startups can make their industries, and at the same time our unhappy society, more prosperous, investments in promising projects will also support these efforts.
Disadvantages of investing
Usually, where there is sweet honey, there are bees buzzing with stingers in their asses. Ninety percent of startup projects burst like soap bubbles, failing. Thus, the chance of making a profit from a single startup has a ghostly 10 percent, looming somewhere on the horizon.
Of course, you can say: there is an opportunity to invest in VC. Go ahead! But we hasten to disappoint you: the best and most promising VCs are private, and require a minimum investment amount of over $100,000. So what is the right choice to make and benefit from?
Four ways to invest in startups
Perhaps the oldest, most common way of investing is through venture capital. However, for people who have never done this before, it is still like starting a collider: very interesting, you want to, but nothing is clear at all. Therefore, it is worth explaining everything in turn.
Regular funds consist of several types of shares. Thus, by investing in a fund, you invest in several companies at the same time. The idea behind this is to diversify risks: the risk of losing your money is spread across several shares, and thus reduced. Funds are usually seen as long-term investment opportunities. Therefore, there are completely different rules of the game here. We will explain them now.
Why are private VCs more suitable for wealthy people? When investing through them, you can count on a very experienced manager who will do everything possible to make the company profitable. By the way, these funds do not just give startups money, but also help them. For example, they offer logistical support, develop strategies, optimize work processes and provide access to a large network of experts.
Such a fund not only filters out the best, but also actively helps these startups become successful so that the investment in them pays off, but not for free. They are not very similar to altruists. All these efforts are paid for by deducting a certain percentage of your investment (it can be from 10 to 20 percent). There is also a minimum investment amount - a certain amount of money that must be invested before getting into this fund. And it is quite a lot. Usually, in order to get into each fund, you need at least 100 thousand $. Some funds even require half a million.
However, thank God, there are exchange-traded funds (ETFs). Anyone can invest in them, but there are very few of them. However, there are commissions and a minimum investment for ETFs, although it is much lower (usually around 250$).
The list of venture funds for business projects in Ukraine includes one SMG Capital, founded in 2024 by three Americans. In order to become a happy co-founder, you need 25,000$. There are about 10,000 such financial organizations in the world.
Before accepting a startup into its fund, it is assessed how profitable it is in terms of profit, and only then its positive impact on society. Provided that it offers greater added value for society and is profitable at the same time, it can be financed. Finding startups that will "survive" is a difficult task in the region.
Investment steps
1. Venture capital
To become part of a venture capital fund, you need to find out whether it is private or public. You should start with private funds, because VCs are almost always private. Often, communication with a VC is done through a contact person. If there is no contact person, you will have to contact the fund through its homepage. You can often find an email address there. You can view the VC's portfolio on its homepage. It applies to all startup projects in which it is investing or has already invested. Based on this, it is important to assess its prospects.
With ETFs, it's much easier. It works exactly like investing in stocks: you just need an online broker.
2. Through crowdinvesting — many small investors
Crowdinvesting is almost like crowdfunding. The difference is that there is an investment, not a donation. Many private investors come together to invest in a startup. They do this through online platforms such as Seedmatch, Companisto, Innovestation. Each platform regulates the minimum investment amount for participation individually. Crowdfunding platforms make money by demanding a percentage of the total investment amount.
Since only one startup is invested in, the risks are not diversified across projects, as is the case with venture funds. That is why it is riskier. Especially when you consider all the 90% startup projects that have failed. But it does not provide a fully transparent understanding of the company's internal processes. Most projects are financed with subordinated loans, essentially a kind of lending process. Ultimately, the invested amount is returned - with interest.
That is, you work like a bank that issues a loan for which you have to pay interest. However, these interests are also much higher than those of other investments. How high they are depends on each individual project. Therefore, as an investor, you must be able to assess whether the potential profit is worth the risk.
And if a startup goes bankrupt, it is obliged to return the money it has to all investors. However, you will get yours last when you take out a subordinated loan (hence the term “subordination”). Lenders - banks, get their money first.
And if there is nothing left as a result, you will get nothing either. However, there are crowdfunding projects that are not financed by subordinated loans. For example, you can get profit participation certificates (PPCs). According to Wikipedia, PPCs are securities, representing a securitized form of profit participation rights. Thus, they are something between stocks and bonds. With the help of PPCs, it is possible to participate in companies without owning shares.
3. Business angel, venture capitalist
Few people can afford this type of investment. If you have a lot of money and are very eager to invest, try becoming a business angel or venture capitalist. Both are people (although in terms of wealth they are more like celestial beings). They give startups a lot of money (usually from 200 thousand $). Everything is at your own peril and risk. If the money disappears and the startup turns out to be insolvent, they do not demand anything back. However, when it is successful and gains publicity, they receive a lot of profit.
The difference between them is quite significant: business angels are particularly well-versed in the industry in which the startup operates, help with networking, and are also interested in the success of their young companies not only for financial reasons, but also for personal ones.
4. Buy startup shares
You can buy shares of startup projects through a regular online broker. You can only do this with those that are listed on the stock exchange and have already proven themselves. Therefore, you cannot count on the same high profitability. However, it is possible that the value of a startup will double several times after an IPO (initial offering). At the beginning of its existence, Tesla shares cost a little over 17$. In 2021, one share cost over 350 $, and today it is 403.84 $.
Startup analysis
Investing in new projects always involves some risk, but if you make the right choice, you can make a profit. There are several key points. They should be taken into account when analyzing to minimize the chances of failure and maximize the chances of success. Here are some tips:
1. Assess the market
- Market size. Estimate the market size for the startup's product.
- Trends and demand. It is important whether there is a demand for it currently, or whether it will increase in the future.
- Geographic location of the market. Find out if the market is limited to one region, country, or has the intention to expand internationally.
2. Team
- Founder experience: Find out if the founders have experience in the sector.
- Team composition. Do team members have a broad range of skills, including marketing, sales, finance, and technology?
- Reputation: Examine the reputation of the founder and key team members.
3. Technologies and products
- Innovation. How innovative is a product, whether or not it has a competitive advantage in the market, compared to existing solutions.
- Product development stage. It is important to know what stage the product is in: at the MVP (minimum viable product) stage, or already working in the real world.
- Technology potential. Assess the likelihood that the technology will develop and improve in the future.
4. Competition
- Major competitors. Can the project offer something unique to compete with large companies?
- Barriers to entry. How difficult it will be for other companies to enter the market and compete with the startup.
- Market advantage. The possibility of having a unique competitive advantage that is difficult to copy.
5. Financial results and business model
- Scalability of the business model. Assess the scalability of the business. Financial projections. The realism of financial plans and revenue projections for the coming years.
- Risk and reward. High-risk projects can promise a lot of money, but they can also bring significant losses.
6. Legal considerations
- Property rights and patents. Make sure the startup has rights to the product.
- Regulatory issues: Assess the possibility of encountering regulatory and legal obstacles that could hinder its development.
7. Support and infrastructure
- Partnerships. The presence of strategic partnerships that can help it develop.
- Support from investors and mentors. Is there support from experienced investors/mentors to help you solve problems and expand your opportunities if needed? Remember: a promoted project is not a guarantee of success.
Conclusion
For most people who dream of investing in startups, crowdfunding, ETFs, and buying stocks are the most suitable options. For very wealthy people with experience and contacts in a particular industry, private VCs are a good fit. Such people can invest in projects directly as business angels or venture capitalists. The riskiest option is to invest in just one startup, as there is no risk diversification, and only about 101% of all startups are successful.
