Investing in Startups / Robbie Paul
What is a startup?
It’s not a publicly traded company on the NZ or ASX– it may not be a proven business yet, it may not be profitable, and it may only be just getting started. A start up could be a seed, a sprout, or a seedling – an idea, some sort of product, perhaps even some revenue coming in.
Founders or a fewer number of individuals will own the shares in startups – and because it’s not traded on a share market – this makes it a bit trickier to get your money out.
Who should invest in startups?
Anyone who’s constructing a diversified portfolio, or collection of investments) and who may wish to include alternative investments into the mix – Bitcoin, precious metals, fine art are alternative (non-mainstream) investments, and startups fit perfectly in the mix
As with most alternative investments, they may provide an opportunity for exceptional returns.
So who should invest in startups? Anyone who can keep their eyes on the prize and not get rattled along the way – you need to okay with taking risk here.
What are the risks/benefits?
- The startup could eventually go public, and you hopefully get more than you paid for the stake of ownership you have. Alternatively, the startup could get acquired by another firm or even a private equity firm. No matter which way, if you back the right seedling, your reward could be immense – imagine if you were offered Xero shares in 2006 before they went public?
- What about the risks? Well, you could lose everything, especially if you’re investing in only one or two companies. Perhaps the idea doesn’t have legs – perhaps the market changes or the founders of the startup have a falling out.
- Remember that your rate of return, which could be really high in this space, is your compensation for the level of risk that you’re taking
What position should you be in before you consider investing in start ups?
This is really important.
When you’re younger, it’s more appropriate to take high levels of risk when investing, but that’s kind of hard considering most younger people have high debt levels, not a lot of cash reserves, potential income disruption by having children and all the rest – really, you want to be in a position I think where at the very least, you have no short term personal debt (like no credit card debt or hire purchase debt), a decent buffer of cash to get you through 3-6 months, and you own your own home. Some would say you’d want to be debt free on your own home also – but I wouldn't be that dogmatic here.
You also shouldn’t be investing in startups if you think you’re going to need that money back in the short to medium term. If you think you can live perfectly fine without seeing that money for a very long time (or even ever), then that’s a good sign you have enough spare capital to allocate to this asset class. Startup investing is very illiquid - you cannot convert it back to cash easily and quickly.
A note regarding the core/satellite investment approach: Some may choose to build their satellites (direct shares, alternative investments) first or others choose to build their core first (which is your mainstream stuff). Now what you choose to do is what you choose to do here – but your decision could be a function of: Your current position; Your perspective on taking risk with money, or even some market timing considerations. I know many would suggest you want to build a decent portfolio of mainstream investments first, but that doesn’t give the everyday investor enough of a runway in my opinion for a higher risk investment like startup investing to bear fruit.
All things considered, and I'm still learning here also, I have two big problems with investing in startups:1- the barriers to entry are quite high. Often,...