You may have learned that there are lots of investment opportunities to allow average folks to get involved in investing in order to grow their money — but doesn’t the stock market ultimately benefit the biggest companies around? What if you’d prefer to grow your money by supporting small businesses? If this rings true for you, you may want to invest in startups.
But what does that entail? In this article, your friends at Academy are going to help take some of the mystery out of how to invest in startups so that you can consider this money-making opportunity.
How does the stock market work?
First things first — Let’s clear up any doubts about how “traditional” investing works so that you can understand why it’s different to invest in startups.
The basic premise behind investing is that you put money into a company, security, or something else with the hopes that you can make it more profitable — and eventually receive more than what you originally invested. This is true for folks who invest in startups and stock alike.
Read also: A simple guide to start investing in stocks
A stock exchange works like a giant, global auction house. In a regular auction house, art, fancy furniture, and other objects are sold off to the highest bidder. A similar process occurs in the stock market: brokers and traders purchase and sell securities to make money. That means that they have to sell their securities for more than they initially bought them.
Companies on the stock exchange are large and seek support from the public to grow even larger. After listing their IPO when they first debut on the stock market, shares of their stock are successively traded. When its stock prices increase as the company performs well, shareholders make money. In turn, companies use shareholders’ investments in them in order to grow their businesses and make even more profit.
When this process works as it’s intended, the company and shareholders all make money. But when the company loses value, shareholders also lose money on their investments. This same dynamic holds true for startup investors, but it doesn’t happen on the stock exchange.
Investing in startups or in the stock market?
One of the main differences between investing in stock and startups has to do with the companies themselves. Companies on the stock exchange are already profitable, larger, and have probably been around for more time than startups. In other words, they’re more mature than the nascent startup business.
But that doesn’t mean that startups can’t be profitable, too. Consider that Google, Amazon, and Facebook all began as startups (and eventually became part of stock exchanges because they became so profitable).
When you invest in startups, you provide money at the beginning of a business’s journey so that they can scale up their idea, expand, and build their networks. Ultimately, all of this can help transform the startup into a more mature (and profitable) company that may someday debut on the stock market.
Since startups are smaller and younger companies, they often entail greater risk. If the company never flourishes, your investment could be a wash. However, if the startup is successful, you could make a lot of money.
For example, seven years after investing $500,000 into Facebook, Peter Theil sold most of his shares at 800 times his initial investment — making $400 million in the process. Most startups never reach the level of success of Facebook. But that doesn’t mean that you shouldn’t invest in startups.
Why do people invest in startups?
Startups are often innovative, change-making ideas. They may be attractive options for investors for a number of reasons.
If the idea takes off, investors may find that their initial investment becomes wildly profitable a short time later — more than any steady, slow-growing ETF or mutual fund. Similarly, investing in startups is a great way to diversify one’s portfolio. New businesses may perform better when larger companies take a hit or the stock market faces an unexpected downturn.
Finally, supporting a particular startup might be a way for folks to invest in what they see as positive change. A new product or innovative idea can help bring about meaningful change in the world — meaning that you can enjoy both a financial payoff and personal gratification if you invest in startups.
How do I invest in a startup?
Depending on the business, its stage of development, and future projections, there are a couple different ways to invest in a startup. You’ve probably heard of angel investors who invest hundreds of thousands of dollars into up-and-coming companies like Amazon and turn a massive profit afterwards.
But what if you don’t have that much money to invest? What if you’re not sure what startup founders you should trust with your money?
You might consider investigating online crowd-funding platforms. After startups have gone through tough vetting processes, they present their ideas (and founders) on the website. You can get to know the stories behind the startups, evaluate how profitable you think they’ll be, and learn about founders’ stories.
You can even choose to support particular types of founders (women or minority-led businesses, for example). For the average investor, these platforms can be great options because you can often invest as little as $10 in a startup.
You don’t have to be an angel investor making a million-dollar deal to invest in startups. Taking advantage of the opportunity to invest in startups can diversify your portfolio and support businesses that you care about. Plus, online platforms make it easy for almost anyone to get involved in investing.
For more investment ideas, check out the rest of the Academy library!