In the last few decades, start-ups have arrived in every industry possible and have changed the ways many people solve problems, shop or receive services. Start-ups have become an important part of every country’s economy, and successful start-ups have created new concepts and ways of doing things that were either earlier not possible or difficult to accomplish.
A start-up is a company or project initiated by an entrepreneur to seek, effectively develop, and validate a scalable business model. It is also traditionally defined as a newly established private company less than five to ten years old designed to scale up very quickly. Most start-ups kick-off as minimal operations while developing their initial idea, and then seek additional funding from venture capitalists and angel investors as they build out their businesses.
Start-ups usually refer to new businesses that intend to grow beyond the solo founder, have employees, and intend to grow large. Start-ups face high uncertainty and have high rates of failure, but the minority that goes on to be successful companies can become large and influential. Some start-ups even become unicorns, which are start-ups valued at over a billion dollars.
Start-up investing is now becoming more popular than ever due to the success of many start-ups and the economic weather supporting start-up growth.
According to experts, start-up investors are essentially buying a piece of the company with their investment. In exchange for equity, they are putting down capital: a portion of ownership in the start-up and rights to its potential future profits.
Investors form a partnership with the Start-up Company they choose to invest in and make a proportionate amount of returns depending on the company’s success and profit. If the company fails, which is also highly probable, the investors lose the capital they invested.
Look for liquidity events
Start-up investors realise a profit from their investments when they sell part or their entire portion of ownership in the company during a liquidity event, such as an IPO or acquisition.
A liquidity event is an opportunity to turn money tied up in equity into cold, hard cash. A common example is an IPO (Initial Public Offering) – the first sale of stock by private companies to the public – often referred to as “going public”. It usually also signifies that the start-up has reached the level of a ‘real’ public company.
In a successful IPO, the stock price per share rises dramatically from pre-sale values, increasing the value of investors’ holdings and allowing shareholders to trade their stock on the public market if they want to cash in any of their assets in the start-up.
Start-up equity is usually regarded as a high-risk, high-reward, highly illiquid asset class, and hence investing in start-ups is considered a risky investment. Start-up equity is also difficult to sell before a company goes public. However, with the greater risk also comes a greater chance of large returns if the start-up succeeds.
According to business experts, some start-ups will allow investors to sell their stock shares in the company before the IPO; referred to as a secondary sale of stock.
However, many start-ups will issue a right of first refusal, which requires investors who want to unload stock before a company goes public first to offer to sell it back to the start-up or its early investors. Most start-ups also put restrictions on the secondary sale of common stock or stock held by founders and employees.
Start-up investing has both advantages and disadvantages.
Unfortunately, 90 per cent of all start-ups fail. Some will return only the money you initially put into them, leaving you exactly where you started – no loss, no gain, which, of course, is better than losing all the money you invested in the company. However, the good part is that just one successful start-up investment could offset all your losses. According to experts, Investing in one big winner could make up for all of your failed investments, and still leave you with an enormous profit.
So what have you decided? Are you ready to invest in start-ups now?