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Start-ups hold the promise of innovation, disruptive technology, and the potential to become the ‘next big thing.’ This is why if you invest in a start-up you’ve a real opportunity to earn a substantial return.
In this article, we’ll explore how investors can capitalise on the potential of start-ups to generate significant profits, while touching on the all important risks to keep in mind. Keep reading for all the details or click on a link below to jump straight to a specific section…
Nowadays, buying shares is as easy as it gets. Find an investment broker, search for your chosen share or shares, and Bob’s your uncle!
Yet when it comes to investing in start-ups, things aren’t quite as straightforward…
Unless you’re a high-net worth angel investor with the financial clout to invest vast sums, you’ve essentially two options if you want to invest in a start-up.
You can either opt to use a crowdfunding platform, or put your money in a venture capital fund. Let’s take a closer look at these options.
Crowdfunding has gained huge popularity in recent years.
As the name suggests, crowdfunding refers to a crowd of people pooling together to fund a new venture.
When you sign up to an investing crowdfunding platform you’ll come across a host of new firms seeking to raise capital. These firms will usually share a sales pitch, business plan, and will often happily respond to messages from potential investors.
When using a crowdfunding platform it’s vital that you do your own due diligence. This is so you can understand exactly what you may be getting yourself involved in. If you don’t know anything, just ask!
It’s also worth getting your head around any voting rights that you may, or may not, be offered should you invest in a particular start-up.
Importantly, these due diligence checks shouldn’t just involve the company you’re looking to invest in. It’s also vital that you do your homework on the crowdfunding platform you’re planning to use to facilitate your investment. For starters, you should ensure that they’re FCA regulated. Also, pay close attention to fees. For example, it’s common for some platforms to insist on sharing the spoils should your investment turn out to be profitable.
ShareIn, Crowdfunder and Seedr are three popular crowdfunding platforms, though there are many others out there – so don’t just go for the first one you come across.
Once you’ve found a crowdfunding platform you’re happy with and you’re willing to press ahead with an investment, transferring funds to your chosen crowdfunding platform is usually an easy process.
It’s worth knowing that if your chosen start-up fails to raise its funding target your funds will simply be returned.
Another way to invest in in start-ups is through venture capital (VC) funds. Similar to crowdfunding, VC firms pool funds from individual investors to provide financial backing to early-stage and high-growth companies.
When you invest in a VC fund, you’re essentially putting your money in the hands of professional investors who will often have previous experience in identifying and nurturing promising start-ups. VC funds typically have a specific focus: for example, technology, healthcare, energy etc.
To get started, you’ll first need to find a reputable VC firm that aligns with your investment goals. On this point, it’s important to take the time to research different firms and evaluate their track record, investment strategy, and the expertise of their investment team.
In the UK, there are several VC firms. Some well-known firms include Ascension, MMC Ventures, and Balderton Capital. However, it’s important to do your own due diligence to find a fund you’re happy with.
Once you’ve identified a suitable fund, you’ll most likely need to commit to a minimum investment. This can be a stumbling block for many investors as it is not unusual for a minimum investment to be in the region of £10,000.
Just like with crowdfunding platforms, VC investments are illiquid. This means your capital will be tied up for an extended period of time.
If you decide to go with a VC fund then it’s also important to be aware of any fees. VC funds typically charge a management fee which is usually a percentage of the committed capital. Fund managers may also expect a percentage of any profits. Again, do your research to understand the exact charges you’re likely to have to cough up.
If you’re looking to put your money towards a worthy cause, or you’re keen to back an industry you think will grow future, then investing in a start-up is likely to be an attractive proposition.
After all, unlike investing in ‘mainstream’ stocks or buying a nondescript exchange-traded fund, investing in a start-up means you’ll be eager to scrutinise the business plan of a brand new company. You’ll also want to do some analysis to discover whether an unusual idea will take off. Depending on your interests, this may all be rather exciting!
Perhaps the most obvious draw of investing in a start-up, however, is the appeal of earning big bucks. For example, if you’re lucky enough to invest in a start-up that enjoys substantial growth in a short period time , and potentially takes the world by storm, then there’s no limit to the kind of return you can earn.
Yet let’s not beat around the bush here…. the potential for high returns also means there’s the potential for very big losses! (See the section below).
1 in 10 start-ups eventually fail within 10 years. This means that if you pour your money into a start-up that doesn’t make the cut, you’ve every chance of seeing your hard earned capital disappear.
This is why it’s really important to appreciate the high-risk nature of investing in start-ups.
However, while the risk of losing everything cannot be eliminated, you’ll almost certainly have more confidence that your investment won’t fail if you conduct your own thorough research. For example, make an effort to investigate your chosen start-ups business model, leadership team, and potential for scalability. Meanwhile, take a deep dive into their financial situation, including revenue projections and funding history. If anything makes you feel uneasy, then you may wish to keep your pounds in your pocket.
Investing in something you understand, is far, far better than investing in something you don’t.
And finally, when it comes to any type of investing, diversification is key. This particularly applies when investing in high-risk start-ups. This is why you may wish to allocate any start-up investment across different industries, sectors, and stages of growth. By spreading your risk, this increases the likelihood of capturing significant returns from the next big success story while minimising the potential for gigantic losses.
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Disclaimer: When investing your capital is at risk. Remember, the value of any investment can both rise and fall. The companies listed above are not endorsed by Money Magpie. Always do your own research.
MoneyMagpie is not a licensed financial advisor. Information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence.