Investing in the next Uber, Google, or Warby Parker before the companies go public can create life-changing wealth, but those higher potential rewards come with much higher risks. That's why investing in private companies has historically been restricted to only certain wealthy or professional investors... until recently.
How does startup investing work?
Just like investing in the stock market, you’re buying a share of ownership in the company. You’re giving the young company money to build its team and product, and you get equity in return. Your share of the company, your stock, gets more valuable as the company grows and gets more valuable.
Investment profits don’t come as quickly with startups. Startups are private companies, so there’s no market exchange with thousands of investors waiting to buy the share you want to offload. It takes time for a company to grow big enough to list on the stock market. When it does go public, called an Initial Public Offering (IPO), all the early private investors can sell their shares to public investors. Until then, you have to find your own buyer, just like with a home or other private asset. That means startup investors will usually earn their payouts when a big event happens, like when the startup is acquired or goes public. Early investors also have opportunities to sell some of their ownership to new investors at each funding stage.
What are the stages of funding?
It's not all just startup cash to get the idea off the ground. Companies keep bringing on new investors throughout their growth to IPO to accelerate their development. Venture capital, or startup investing, is broken into stages based on the company's maturity.
Many startups begin their earliest stages by bootstrapping, surviving from initial sales or the founders' savings. When startups look for outside investment, they first reach out to friends, family, or angel investors. That's typically called an Angel Round or Friends and Family Round. Angels will invest anywhere from $10,000 to $1 million. This is also known as pre-seed funding, especially if professional startup investment funds called venture capitalists participate.
After seed funding, the startup can start Series funding. This process begins with Series A, when the startup has a business model to present a solid strategy to potential investors. Series B funding takes the business into the development stage, while Series C funding is for successful startups looking to scale up. The series continues until the company chooses to go public.
Do startups sell shares like companies on the stock market?
There a many ways startups can raise the money they need, from taking on debt to selling ownership shares. However, startups typically don't start selling individual shares until they reach Series funding. When companies are very young, valuing their company based on financial traction isn't easy. So they often award investors a contract for future ownership instead of issuing shares with a specific price.
The most common way to do this is through a SAFE note, a Simple Agreement for Future Equity. This contract allows an investor to buy a specific number of shares in the future for an agreed-upon price, usually after the startup is big enough to issue shares or get acquired. Investors will structure the SAFE note with a valuation cap, for instance, investing $1 million at a $10 million valuation cap. The valuation cap is intended to mark the minimum percentage ownership the investor will earn at the next priced round, when the SAFE note converts into actual shares. So the $1M investor locks in that minimum 10% ownership regardless of how much bigger the company gets. If the company gets valued at $20 million in its subsequent funding round, that $1M investor's SAFE note converts into shares worth 10% of that $20 million company, not just 5%.
Can anyone invest in startups?
Investing in private companies, especially young and unproven ones, comes with higher risks. There's much less information to base your decision upon and a higher risk of failure. Ninety percent of startups fail, and 10% will fail within the first year. When a startup fails, you can lose your entire investment.
Because of these heightened risks, regulators have restricted private company investing to only those with professional investing experience or plenty of money to lose. Accredited investors were the only ones able to invest like the pros on Shark Tank until recently.
In 2015, Congress passed Regulation CrowdFunding, allowing anyone to invest in startups through crowd-investing platforms like Republic, StartEngine, or Wefunder for as little as $100. These new investing platforms aren't based on donations like GoFundMe or Kickstarter. It's not charity. You buy equity in the company, making it an authentic investment experience where you benefit from its growth. Equity crowdfunding has exploded in popularity over the past few years as more startups seek funding outside the Silicon Valley elite.
How do I find startups I might want to invest in?
We can help you out with this one. Share Scoops just launched on Republic, and we reached our fundraising goal on our first day! We’ve opened fundraising briefly to our whole community so you can participate in our pre-seed round. Making this accessible has been a goal of ours from the beginning. When Republic asked us to include them in our pre-seed raise, it was a no-brainer. For a limited time, anyone can invest and own a piece of Share Scoops for as little as $100. Learn more here.
We obviously timed this Explained to give you the background you need to take part in this opportunity, and we'll be serving up more information over the next few weeks to help you understand this stuff even better. We hope this opens new doors for you to explore investments usually reserved for the professionals. Keep the risks in mind, as well as all the other Scoop investing principles of diversification, starting small, and strengthening your financial health first. If you have any questions, don't hesitate to ask.
Thanks for being one of our earliest supporters. Let's go change the world together.
Keep building, friends
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