To invest in startups, choose a sector you’re familiar with, spread your risk across multiple businesses, conduct thorough due diligence, and be aware of the risks. Common forms of investment include angel investing, convertible loans, venture capital, and (equity-based) crowdfunding—each with its own risk profile and level of control.
Previously, as an entrepreneur, you may have gone out and looked for investors yourself, but now you are on the other side of the table. Investing in startups can be an exciting new adventure for you.
Find the right promising businesses and enjoy financial returns and impressive innovations within the sector. In this article, we discuss how you, as an SME entrepreneur, can invest in startups yourself. What are the opportunities and challenges?
[1] Preferred industry and startups
As an investor, you undoubtedly have a preference for a sector. Have you been active in the agricultural sector for years? Then investing in a fashion business might be a long way off. Choose a sector in which you yourself have gained sufficient knowledge and expertise to make strategic choices. This will help you assess the potential of startups and enable you to provide support. Don't be impulsive in selecting businesses, take enough time to research the market potential and make an informed choice.
[2] Diversification
Don’t put your entire fortune into a single startup. Although it’s not a casino, it’s still wise to spread your risks. By diversifying your portfolio across different startups—each with its own challenges and opportunities—you increase your chances of positive returns.
[3] Due diligence is priority
Conduct thorough due diligence before engaging with any party. Having background research done by a professional will put the viability of the startup of your choice under the microscope. Study the business plan, speak with the management team, check the backgrounds and dive into the numbers. It helps to have outside experts look in, so you don't get swayed by your emotions.
[4] Be aware of the risks
Investing isn’t all sunshine and roses—it can also be quite disappointing. Investing in startups comes with risks, so be realistic and expect a period where you won’t see an immediate return. Plus, not all investments yield a financial return. Unfortunately, that’s just part of the investment process.
[5] Look beyond just a capital injection
As an investor, you have valuable knowledge and experience that is unique. Don't be afraid to share this with the startups you invest in. Financial support is tremendously nice, but the right coaching, connections and knowledge may be worth even more! By actively doing your part, you are not only helping the entrepreneurs, but ultimately yourself.
How can you invest in startups?
After reading all these helpful guidelines, you’re naturally wondering how to invest in startups. There are several options, which depend on the size of the investment, the type of startup, and your personal preferences. These are the most common types of investments:
- Angel investment, where you as an entrepreneur invest money in exchange for shares in the startup. Whereas as an entrepreneur you would want as little control as possible from an investor, now that you are on the other side of the table, it is smart to acquire as much control as possible;
- A convertible loan is also an increasingly common form of financing. This hybrid form is attractive to you as an investor because you are somewhat protected if the startup's intended successes fail to materialize;
- Venture capital is equity capital with a high-risk profile that you provide to a startup in exchange for shares. You don’t know whether the business plans will actually be realized. However, as an entrepreneur, you often have the opportunity to provide strategic guidance, so that you also have a say in the matter;
- There are also several crowdfunding platforms that offer the option to invest in startups. While there are various types of crowdfunding, equity-based crowdfunding is still the most well-known form of investment. In exchange for your investment, you receive a stake in the business, which can yield dividends or capital gains once the startup begins to grow.
There are many options and probably many startups waiting for an investor. Be aware of the challenges, opportunities and consequences and explore your playing field. It would be a shame if you impulsively step into a project and don't get a return.
Frequently Asked Questions
How do you get started investing in startups?
First, choose an industry you’re familiar with, spread your investment across multiple startups, and always conduct thorough due diligence before investing.
What are the most common ways to invest in a startup?
The most well-known forms are angel investing, convertible loans, venture capital, and equity-based crowdfunding. They differ in terms of risk, control, and the level of protection for the investor.
What’s the difference between venture capital and a convertible loan?
Venture capital is equity capital provided directly in exchange for shares. A convertible loan starts out as a loan and therefore offers more protection if the startup underperforms, but can later be converted into shares.
What are the risks of investing in startups?
Startups can fail, and not every investment yields a return. Also, keep in mind that it may take a long time—if at all—for an investment to pay off.
As an investor, do you only need to contribute capital?
No, many investors also offer startups knowledge, coaching, and connections. For a young business, that’s often just as valuable as the investment itself.
