And the third is to create a social good, whether you’re investing in someone you’re already familiar with or contributing toward a broader cause. “The traditional model is that if you invest in 10 startups, you’ll lose everything on seven of them, earn a minor return on two, and maybe, if you’re lucky, make a big enough return on the last to subsidize the rest,” said Nadel. “This provides some early evidence of product-market fit,” he said.
Accredited investors on AngeList have long relied on syndicates (like Nadel’s) to pick companies for them. “A lot of groups are underrepresented in startup funding. It takes on average 7-10 years to see if your investment has panned out, and because startup investing has no liquidity, you won’t be able to sell your shares if you find yourself in a tough spot. While you won’t see an immediate tax deduction, if an investment pays off you can roll its proceeds into future ventures. It’s also easier to understand — look at this chart!. “No one sinks half their life into a season for the cash prize. If you lose interest after a week, perhaps this approach isn’t for you.
As long as entertainment investing is done with hobby money, it’s no better or worse than seeing a play or taking a wine class. Mix up the geographies, the business models, and the platforms so that a blight in one category won’t wipe away the sum. Who are the people behind-the-scenes deciding on what startups to list? What’s their vetting process like? Do they have skin in the game? Do they list companies from every industry or focus on a few? I’ve noticed that the platforms differ wildly on these questions.
Research broader trends. Before you get swept up in a hype video, nail down your motivation and devise a plan.
“There are at least three reasons why people should invest in an equity crowdfunding campaign,” Slava Rubin, Chief Business Officer of Indiegogo, told me. Note that if you are not an accredited investor, the government sets rules on how much you can invest per year based on your income.
The second step is to invest in a lot of startups. While exciting, this development is fraught: Many will get drawn into the tempestuous world of startup investing without a plan, a budget, or a full understanding of its pitfalls.
If you’re new to startup investing and considering it, here are a few things you should know before going in.
The haves and have nots
Despite the headlines, if you don’t meet the wealth requirements to qualify as an “accredited investor,” you still can’t invest in the majority of opportunities. For example, if you’re investing seriously, you must diversify your holdings to offset risk, but if you’re investing as entertainment, then diversification might prove distracting.
Motivation will also inform the source and size of your budget. That’s because a startup raising money from everyone and not just from accredited investors will have to follow a different set of rules, like limiting their raise to $1 million. “We want them to be as prominent and easy-to-use as ETFs,” she said.
Equity crowdfunding as entertainment
I asked Nadel for his thoughts on equity crowdfunding as a form of entertainment. Some have an obvious social aspiration, like Maternova, which develops clothing to help women in developing countries ward off the Zika virus. Join leading AI executives: Register for the free livestream.
However, Vladimir Vukicevic, an early pioneer in crowdfunding and the CEO of crowdfunded Meural, says accreditation requirements are routinely flouted. If you’re not as knowledgeable about a space, consult a friend or colleague who is. Investing in a startup has that thrill, and if the startup does well, it also has bragging rights.”
As a side benefit, obsessing over one startup can be an education. Just remember to scrutinize the startups you invest in. After a long pause, he said, “That sounds like an easy way to lose a lot of money quickly.”
It certainly is. Investing in a startup is riskier than buying a penny stock, so yskip this article if you haven’t already taken care of the basics, like setting up an emergency fund, paying off your credit card debt, and maxing out a Roth IRA.
If you pass inspection, here are a few prudent steps on how to add startup equity to your holdings.
Phil Nadel, a seasoned startup investor and Managing Director of Barbara Corcoran Venture Partners, one of the largest and most active AngeList syndicates, recommends a first step of setting a budget.
Nadel recommends a maximum of 5 percent of investable assets as a rule of thumb. Your goal should be to nurture good ideas, not prop up bad ones.
Another approach is to consider social value as a checklist item when building a financially motivated portfolio or investing for entertainment. “10 isn’t a large enough portfolio though.”
The sixth step is to do your due diligence by researching the company. Over the last year you’ve probably seen a variation of the headline, “Anyone can now invest in startups!” With the birth of equity crowdfunding, we’ve seen the launch of new platforms, including one by Indiegogo, that let the average person back companies for profit instead of just for product or perks. In fact, it’s more fiscally sound than America’s biggest hobby: buying lottery tickets.
Equity crowdfunding as social activism
As an executive at AngelList, Ken Nguyen had a front-row seat to Silicon Valley’s funding patterns–and he grew frustrated with what he saw. And 50 hours of an experience at $500 is a better rate than a movie ticket.
Vukicevic likens it to fantasy football. If you’re a lawyer who bills $300 an hour and you burn three hours of research into a $250 investment, then … well, you get the point.
So how do you invest responsibly without overdoing it on the due diligence? Rather than focusing on individual companies, spend your time researching high-level items:
Research the equity crowdfunding platforms themselves. Others are more traditional ventures, like Whim, a dating app with a unique hook.
Republic highlights a third motivation for equity crowdfunding: investing as social activism.
If you’re passionate about tech diversity or want to foster innovation in an underserved market, then investing in the right startup could represent a more intimate and impactful contribution than writing a check to a global non-profit.
One approach is to invest with no expectation of a return, treating your investment as an exercise in charity and transferring funds from your annual charitable giving pool. The equity crowdfunding platforms contain plenty of educational resources to help you get started, like SeedInvest’s Academy. The government has erected legal blockades against international deals, and most offerings are consumer-oriented, meaning the massive enterprise market is underrepresented.
The fourth step is to plan for the long-term. With our example budget of $5,000, investing in 20 startups means an average of $250 funding per startup.
The third step is to make sure that your startup portfolio is diversified. For example, knowledge about the VR industry can cover multiple VR investments and help you spot the stars. Syndicates take a cut of earnings (“carry”), but in exchange they spend an enormous amount of time vetting each startup they select. They do it for the thrill of the process and the week-to-week bragging rights with friends. For example, don’t invest your $5,000 into 20 consumer VR startups on the same platform.
You may struggle with diversification. “The first is to earn a return. Fred Wilson’s AVC blog is also a classic resource.
Aside from broad research, Nadel offers a simple due diligence “hack” if you’re risk-averse: Limit investments to companies that already have revenue. But this advice comes with a big “gotcha”: If you’re only putting $250 into a startup and value your time at all, then every hour you spend researching and vetting that startup indirectly shrinks your return. Nadel recommends 20-30 for a reasonable portfolio. Age, gender, ethnicity, and geography play a disproportionate role,” said Nguyen, “and some socially important markets are neglected altogether.” To fix that, Nguyen founded Republic, an equity crowdfunding platform with a social slant.
The majority of startups on Republic are women or minority-led. For now, one platform, Fig, already offers an alternative by letting you invest in products instead of companies. One of the tragedies of startup investing is that you can invest in a company that does well — with products on store shelves — but you’ll lose everything if it doesn’t do well enough.
There are methods to change that (secondary markets, planned dividends, or debt-based investing), but these methods carry their own complications. “If you look at the crowdfunding horror stories of the past,” said Justin Bailey, CEO of Fig, “the vast majority wouldn’t have stood up to a domain expert’s scrutiny in the first place. Early data on syndicate performance is compelling.
By law, non-accredited investors have no syndicate equivalent, but there are alternatives. It’s often based on the honor system, so some investors broaden their portfolio with little hesitation.”
I’ll let you kick around the implications there, but the important thing to know is that “Anyone can now invest in startups!” should be qualified as “Anyone can now invest in certain startups!”
Nailing down your motivation
Remember that Grandmotherly advice about never going to the supermarket hungry and without a grocery list, because you might end up with excess candy in your cabinets and an upset stomach? The same advice holds for equity crowdfunding. If you trust the syndicate itself, you can trust the startup by proxy. One is SeedInvest’s index fund. Picking a few non-traditional startups for your portfolio may even give you an edge, since overlooked entrepreneurs and overlooked markets might help with diversification.
Is there an alternative model?
If you invest in a startup, you’ll generally only receive payment if that company is acquired or goes public. Alexandra Tynion from Seedinvest sees managed and diversified startup index funds as the future of equity crowdfunding. But if approached with thoughtful restraint, entertainment can be a viable approach.
Remember earlier, when I talked about the big “gotcha” with due diligence? That every hour you spend vetting small investments results in a lower return? Well, that’s only true if you think of the time spent as a cost rather than as the entire point.
If you invest $500 into one startup and enjoy scouring its financials, researching its product, asking its founder questions, and following along as it grows, then you’re not buying equity, you’re buying an experience. Will you draw funds from your retirement savings? From your disposable income? Or from your annual charitable giving pool? The difference in scale between retirement and entertainment investing might be a factor of 100.
Equity crowdfunding as serious investing
If you approach equity crowdfunding as a serious investor, then the rest of your financial scaffolding must be robust. They’d have been exposed after a 30-minute phone call.”
Research startup investing in general. (Those products are all video games for now, created by established video game developers, but you can imagine the model expanding to other categories.) In return for your investment, you’re paid royalties.
A royalty structure shrinks your time horizon, increases your success rate, and changes outcomes from black and white to shades of grey. The interesting thing about crowdfunding is that the same company can have backers with wildly different motivations.”
The three motivators (financial, entertainment, and social) have overlap, but it’s important to figure out which one will drive your investing ahead of time, because that will inform your strategy. SeedInvest serves both accredited and non-accredited investors.
VB Transform 2020 Online – July 15-17. The second is for the joy of the process. You’ll learn a lot about startup finance, which is itself a fascinating area, but you’ll also build literacy in your startup’s vertical. If you’ve already saved $100,000, then a $5,000 investment budget might be a good place to start. I can imagine the accountant who invests in a machine learning startup, gets inspired to learn the basic principles, and then hires a developer to apply machine learning to his or her own practice.
If you want to invest in a startup for the journey, then start small and see how much mileage you get out of the ride. “The dirty secret of equity crowdfunding is that the platforms don’t seriously vet investors to make sure that they’re accredited. This has bifurcated equity crowdfunding platforms into two classes.
Established platforms like AngeList and CircleUp remain exclusive to accredited investors, while upstart platforms like Republic, WeFunder, Indiegogo, and Fig are open to everyone. Think of startup investing like buying into a retirement fund: Set it and forget it.
The fifth step is to calibrate your expectations.