Investors are no longer limited to public stocks. The 2016 US Securities and Exchange Commission Crowdfunding Regulation gave the…

Investors are no longer limited to public stocks.

The 2016 U.S. Securities and Exchange Commission crowdfunding regulations gave the green light for ordinary investors to invest in start-ups. Investors can now access more options in the private market and pre-initial public offering opportunities.

As fewer companies go public and more companies stay private for longer, you might be interested in expanding your investment opportunities in rapidly growing startups.

Now that ordinary investors have access to opportunities in the private market, it is important to determine if alternative investments like startups have a place in your investment portfolio. Here’s what you need to know about investing in start-ups:

– What is a startup and why invest in a startup?

– How to choose a crowdfunding platform.

– How to evaluate the startups in which to invest.

– The risks of investing in startups.

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What is a startup and why should you invest in one?

A startup is a business that creates a product or service from scratch. There are different stages in the development of a startup, as the business gradually grows and finds its place in the market. Startups tend to be disruptive and innovative; they are trying to find solutions to an existing problem.

Because of these characteristics, startups can be a strategic way to diversify your investments.

One of the reasons to consider investing in startups is simply because they are now accessible to ordinary investors.

Private markets are much larger than public markets, and although they are riskier, it makes sense for retail investors to explore these opportunities now that they have access to them, says Swati Chaturvedi, co-founder and CEO of the platform. Propel (x) investment.

If you want to invest in startups that you believe in, it’s best to get into them early on – or what’s called the seed funding phase, where the money is used to get the business started. You can also get started with a startup in subsequent funding rounds, but this could present a higher barrier to entry because at this point a business is more developed.

Another reason to invest in startups is that they have the opportunity to generate above average returns. The flip side of being a high risk investment is that there can be a lot more room for startup growth compared to publicly traded companies.

“Usually, state-owned companies, especially nowadays, are at least in the single-digit billions in terms of valuation and can only grow to a certain extent, while for start-ups they are at one or more. two digits. millions in terms of valuation, and there is obviously a lot more room for improvement, ”says Adam Moelis, co-founder and CEO of Yotta, a personal savings platform.

Startups as alternative investment also offer investors another way to think about your portfolio allocation strategy.

“Instead of saying 70% stocks and 30% bonds, I’m going to go to 60% stocks, 30% bonds and 10% alternatives,” says Chaturvedi.

There are several categories within alternative investments, startups one of them, and you should own some of your alternative asset allocation, she says.

How to choose a crowdfunding platform

Investing in startups has been simplified with crowdfunding platforms allowing investors to access startup investment opportunities.

Find out how a prospect crowdfunding platform is structured. Many companies are looking for financing. That said, research the percentage of companies that are ultimately selected to be on the platform. Does the platform itself take a stake in startups? This is an important question to ask, as well as how the crowdfunding platform selects the companies it offers to investors.

“Look for platforms that give you the ability to connect with the founder,” says Chaturvedi. This way, you can ask them questions and learn more about the business right from the source.

Depending on the crowdfunding platform, there may be different entry points. You can find a platform that allows you to invest as little as $ 10 or up to $ 5,000 or more. Even platforms that have seemingly higher entry points, Chaturvedi says, are still inferior to those in the larger private market.

[Read: Q&A: Why to Focus on Factor-Based Investing]

How to evaluate the startups in which to invest

Public companies are required to report their financial statements on a quarterly and annual basis. These reports allow investors to learn more about a company’s growth prospects and financial condition.

But startups are not required to provide financial reports to the public. This can make it difficult for investors to do their due diligence. That said, there are ways around this challenge.

One way to find out more about a business, says Moelis, is to assess other investors in the business and see if the business has a well established team.

Check the background and industry expertise of the founder and team, and see if they’ve created any other businesses or products in their niche. If the company has a good team, says Moelis, it can adapt to the market if changes occur.

It can also be helpful for investors to have experience in the industry in which the startup is operating. This way, you can make accurate estimates on the viability of a startup in the future.

Chaturvedi says there are two questions investors should ask themselves when researching a startup: What is the startup’s market potential and is there competition?

Being aware of industry trends and understanding how a startup fits into this space allows you to make better informed and potentially more lucrative investment decisions.

Moelis also recommends embarking on an investment taking into account your risk-return profile. Many startups struggle early on and often fail in the early years of development. So, as he says, understanding the statistics for this alternative asset class will put investors in the right frame of mind to set their expectations.

[Read: How to Build an Investment Portfolio.]

Risks of investing in startups

Since startups are a high risk investment, Chaturvedi suggests that investors “only invest the money you are prepared to lose.”

Experts say diversifying among startups is a good way to mitigate risk in this alternative asset class, rather than focusing on one or even a few startups. By investing in lots of startups, you have a better chance of finding a successful business.

Chaturvedi recommends investing in 15-20 startups, as the majority of startups end up failing.

“If you invest $ 100,000 in 10 companies, $ 10,000 each, you’ll find that the first thing you do is lose $ 50,000 of your money, and that will happen in a year or two. So your portfolio could be underwater for a while because the best companies are built and don’t see an exit for a long time, ”she says.

If a startup’s market does eventually collapse, your investment may end up falling to zero. “A lot of these startups don’t have a track record, so you’re betting on a vision,” says Moelis.

Startups also have liquidity risk. Your money could be tied up for seven to ten years. The money you invest is not accessible to you for a long time, and there is a possibility of not seeing this money again.

Since there is a high probability of losing money, “make sure it is a small percentage of (your) entire investable assets,” Chaturvedi says.

To take with

While startups can be a high-risk investment, investors can reap big rewards if a business is successful across the board. One of the main considerations you need to take into account is how the startup investments fit into your risk tolerance and your overall investment strategy.

To position yourself for profitability, do your due diligence in this alternative asset class and understand all the possible outcomes, both positive and negative. Even if you do your best research, you should know that there is still no guarantee that a startup will be successful.

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