The Pros and Cons of Investing in Startups
Many investors wish they had gotten in early with a startup that became the next Amazon or Netflix, but picking the superstar companies of the future isn't easy.
Most startups will fail. In fact, 18% fail within the first year.1 But investors' appetite for them has been strong. In 2021, global venture capital funding almost doubled compared to 2020.2
Why Invest in Startups?
If you back the right business at the right time, you could make some serious money. That's because there is enormous growth potential in startups that you just don't get with established companies. A lot of the value of a successful company may be created in that rapid-growth period before it reaches IPO (initial public offering) stage or is bought up by a larger business.
A unicorn is a new business that is privately owned, meaning it isn't listed on the stock market, and is valued at more than $1 billion. Facebook (now Meta) and Google (now Alphabet)3 are famous examples of unicorns. Airbnb was also an incredible unicorn success story; the company's share price doubled to value it at more than $100 billion shortly after its IPO on the Nasdaq in December 2020.4 Unlisted companies whose valuations reach $100 billion or more are labeled "super unicorns" or "hectocorns." One of the few in existence3 right now is Elon Musk's SpaceX, which is still privately held. SpaceX is currently estimated to be worth as much as $127 billion.5
Aside from a bumper payoff when a company is bought or goes public, some venture capitalists or angel investors also like the idea of using their capital to support clever ideas from passionate entrepreneurs wanting to solve societal problems.
A lot of the value of a successful company may be created during the rapid-growth period before it goes public or is bought by a larger business.
Startup Investing Opens Up to Everyone
Investing in startups is now easier than ever. You don't have to invest a lot or have the right connections. Instead, you can buy a small slice of an emerging business through peer-to-peer networks (such as crowdfunding sites). The process is simple, and you can invest relatively small sums of money.
An alternative is angel investing. High-net-worth individuals can invest their own capital in a startup. Or they can join an angel investors club to pool their money to fund startups. This is a more complex process and requires a larger upfront investment. An individual might invest $5,000 to $150,0006 at a time, while a small syndicate of three to five angel investors might pour $100,000 to $250,000 into a startup.6
What Are the Risks of Investing in Startups?
There are many risks when you invest in startups. If you're going to dabble in this space, you need to be realistic and not commit any capital you can't afford to lose. The failure rate is high, so you could lose your entire investment if a business goes bust.
Here are some other things that make investing in startups riskier:
- Detailed information isn't as widely available
Because the business you'll be investing in will still be privately-owned, it won't be subject to the same rigorous reporting standards as a publicly-listed company. This means you'll have access to less information about the company and its financial health. This can make it difficult to know when or whether to invest. It also means you may find it harder to assess if the company is being correctly valued.
- Longer time horizon
You should be prepared for your money to be tied up for at least three to five years. You may not see a return on your investment for even longer, if you ever do. Startup capital must be patient capital, and come with low expectations.
- Harder to get your money back
Investing in startups is an illiquid way to invest. If you change your mind about your investment or find you need the cash sooner, it can be difficult to get your money back. While you may be able to sell your stake on the secondary market, there are no guarantees that you'll get your initial outlay back, or even that you'll be able to sell at all.
While new ventures are an exciting and dynamic area in which to invest, they aren't suitable for everyone. Think carefully about your appetite for risk and your tolerance for loss before you commit capital to a startup business, however promising it may look. Talk with your Synovus financial advisor to be sure you have thought through the details.
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