Should I invest in a startup company? You're most likely considering investing in a startup because of the great opportunity to generate significant returns. If that is the goal, then your strategy should be to get in with the right startup as early as possible in its life cycle. The longer you wait, the smaller the return opportunity is going to be. In other words, the less the risk, the smaller the return.

How to Invest in a Startup

Investors can purchase company shares online through crowdfunding platforms, buy into a privately managed startup or venture capital fund that invests in pre-IPO opportunities, or work directly with a local company to buy a percentage of equity.

Public funding for startups was entirely different twenty years ago. Today, new startup funding options offer entrepreneurs numerous ways to turn their great ideas into reality. For an investor, the possibility of investing in the next big business can be an exciting venture. Kickstarter was one of the first non-traditional methods to fund a startup. As crowdfunding became more mainstream, everyday people began supporting campaigns or projects in exchange for product discounts or early access.

Crowdfunding opens the door for anyone to fund a thriving startup, but doesn't offer much return for the investor. The appeal is that it provides the average investor with an opportunity to invest with a small amount of capital. Investing in a startup can have many personal and financial benefits.

In May 2016, Title III of the JOBS Act, otherwise known as Regulation Crowdfunding, came into effect. This legislation made it possible for ordinary people to invest in startups by easing the restrictions about who could and could not invest in small businesses and private companies.

Prior to the JOBS Act, an investor needed to have a net worth over $1 million or make more than $200,000 a year to qualify to back most companies. Now the opportunity is open to anyone, however current regulations do set some limits:

  • Individuals who earn less than $100,000 are permitted to invest up to $2,000 or 5 percent of their yearly income.
  • Individuals who earn between $100,000 and $200,000 may invest up to 10 percent of their yearly income.

With the 2016 Securities and Exchange Commission crowdfunding regulation, investing in startups was no longer limited to accredited investors. The opportunity was open to anyone, using a variety of different methods, some of which include:

  • Buying into a privately managed venture capital fund or startup that invests in pre-IPO opportunities
  • Working directly with local companies to purchase a percentage of equity
  • Using crowdfunding platforms to purchase company shares

The Small Business Administration states that about 500,000 new companies are created every year in the United States. Due to the difficulty of obtaining financing, many entrepreneurs choose to ask family, acquaintances, or friends for funding.

Entrepreneurs have been influencing the shape of the United States since its founding. The contributions of such innovations are immeasurable. Capital formulation and creating jobs are two benefits of investing in a startup. Capital formulation relates to growing the stock of real capital in a specific country. To clarify, capital formulation means developing additional capital goods in order to produce future goods, such as:

  • Tools
  • Factories
  • Machinery
  • Electricity
  • Transportation
  • Equipment
  • Material goods

Although selecting which startups to invest in is not an easy game, choosing correctly could generate returns that could yield over 100 times on the initial investment.

Invest in a Familiar Domain

When investing in a domain, it's important to consider:

  • How do the company and corresponding industry operate?
  • How likely is it that the entity will grow to a level which will earn an investor profits?
  • How do the people behind the company operate?
    • Focus on their education, background story, previous work experience, and the value they offer to the company.

Diversify Your Investments

Diversify your investments to improve your success rate and help reduce the overall risk by:

  • Remembering you may not be able to cash out at any time
  • Being patient because these are long-term investments
  • Not relying on one specific investment for a short-term return

Explore the Market

Examining a startup's competition is extremely important. You want to see that a company has a competitive advantage over other new businesses and that it's capable of operating in the mass market. Feedback is critical in the initial phase of a startup. Founders should focus on customer development and be receptive to their clients' comments and criticisms.

If you need help determining if you should invest in a startup company, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.