How to Invest in Startups
Millions of people have started investing in private startups in recent years. They invest for various reasons, including their emotional connection to a startup or its founder, because they want to vote on the future with their money, diversify their investment portfolio, and to make money. In 2022, investment in the private markets totaled $1.2 trillion, with a 2.9% compound annual growth rate (CAGR) from 2017-2022.
The growth in private market investing can be attributed to three primary factors:
- the JOBS Act, which opened the asset class up to non-accredited investors – or regular people to invest in startups
- a new ecosystem of software products and investment vehicles like syndicates, investing clubs, rolling funds, and crowdfunding
- more press and coverage around the returns of early investors in startups like PayPal, Facebook, and Uber
Before we cover how to invest in startups before IPO, the investment vehicles, and which ones may be available to you, it’s important to note that investing in startups is inherently risky. Investing in startups is more risky than investing in the public markets for several reasons:
- You have less information to make decisions when investing in private startups. Startups are not required to follow public reporting requirements, which include CPA-reviewed financials, shareholder updates, and other legally required disclosures.
- Your investment is illiquid, meaning you can’t sell it on a whim like you can with public stocks. As a result, investors often have to wait 5-10 years before ever seeing a potential return.
- There is more variance with valuations – the cost at which you’re buying into the startup. It’s also important to note that valuations in private startups are not always the company’s true value. Startups often go public or IPO at a price lower than their last private financing round.
- Most startups fail. 95% of startups are not profitable. This is by design, as private investors want them to invest the money they make and raise into the company’s future growth. As a result, startups need to hit key milestones to raise more money, or they will die.
How to Invest in Startups
1. Angel Investing
Open to: Accredited Investors
The most common way people invest in startups is called angel investing. This is when a wealthy individual invests their own money into a startup. Typically, angel investors invest $5,000 - $250,000 by writing the startup a check or wiring money to their bank account. Most people start angel investing by investing in their friends – people they grew up with, went to school with, or worked with – when they start companies. As they build a track record, angel investors get more inbound deal flow from startups looking for investment and may meet other angel investors who want to co-invest together.
This is a good option for:
- people who have worked in tech for a couple of years at notable startups or in meaningful roles (product manager, engineers, etc.) – see the top 100 angel investors here.
- people who have a personal brand that can help startups with distribution (celebrities)
- people who have a strong network of entrepreneurs or friends starting companies
This is a bad option for:
- people who don’t have any deal flow
- people who have no tech or startup exposure
- people who are investing less than $5,000 per deal
2. Angel Investor Groups & Communities
Open to: Accredited Investors
If you’re new to investing in startups, joining an angel investor group or community may make sense. The quality of these groups & communities and how they operate varies wildly, so do your research before applying. Some red flags to look for include no investments in notable startups, a considerable upfront cost to join the group, and a slow (2+ weeks) decision-making process.
The most popular angel investing groups & communities:
- Sand Hill Angels, New York Angels, Miami Angels, The Syndicate (more investor groups here)
- First Round Angel Track, Hustle Fund, The Council (more communities here)
- Uber Alumni Investment Club, Uplyft, AirAngels, DashAngels (more alum groups here)
This is a good option for:
- people who have worked in tech for a couple of years at notable startups or in meaningful roles (product manager, engineers, etc.)
- people who want to learn from and work with other investors to make investments in startups
- people who want to share access to deal flow
This is a bad option for:
- people who are investing less than $10,000 annually in startups
3. Angel Investor Platforms
Open to: Accredited Investors
As investor interest in private markets has spiked, startups have built software products around helping people invest in startups online. The most popular platform is AngelList. One of AngelList’s first investment products was the syndicate, when a group of investors pools their capital using a special purpose vehicle (SPV) to invest in a startup as one line on the cap table. Investors in the syndicate invest on a per-deal basis into deals presented to them by the syndicate lead.
The most popular angel investor platforms:
- AngelList Syndicates (more syndicates here)
- FundersClub
- Republic Deal Room
This is a good option for:
- people who are just starting to invest in startups
- people who want access to startup deals
- people who wish to review deals online
- people who want to invest in startups but don’t want to do a lot of work
This is a bad option for:
- people who want to build personal relationships with the founders of the startups they invest in
- people who expect annual updates from the startups they invest in
4. Venture Capital Firms
Open to: Accredited Investors
Unlike angel investors, venture capital firms invest other people’s money. Venture capital firms raise from limited partners. Small venture capital firms may have $1 million in assets under management, while large ones have over $1 billion. The size and structure of the venture capital firm will dictate whether they are raising from institutional investors (pension funds, college endowments, trusts, large corporations, etc.) or individuals (aka potentially you).
The most popular venture capital firms for individual investors:
- AngelList Rolling Funds & Venture Funds (my recommendations here)
- Operator Collective
- Alumni Ventures
The most popular venture capital firms for institutional investors:
This is a good option for:
- people who would rather let professional investors make the investment decisions of which startups to invest in, how much to invest, and at what price
- people who have relationships with good venture capital investors
- people who want to invest $100,000+ annually in startups
This is a bad option for:
- people who want to make investment decisions and build personal relationships with the founders of the startups they invest in
- people who don’t have prior relationships with good venture capital investors
- people who are investing less than $100,000 annually in startups
5. Crowdfunding
Open to: Accredited Investors & Unaccredited Investors
There are various types of crowdfunding offerings and platforms. The most popular crowdfunding platforms, like Kickstarter, Indiegogo, and GoFundMe, are not ways to invest in startups. Kickstarter and Indiegogo help companies raise money through pre-orders, but you are not an investor in the company (i.e., you don’t own shares). GoFundMe is a way to help people and companies raise money, but investors get nothing in return – it’s a charity platform. The crowdfunding platforms recommended below are open to the public and let anyone invest in startups for as little as $100. These platforms include a mix of opportunities to invest in startups and local businesses, as well as a combination of investment contracts, both equity and debt deals. So make sure to read each offering summary before investing.
The most popular crowdfunding platform for startups:
- Wefunder (my review here)
- Republic (my review here)
- StartEngine (my review here)
- Seedrs (European startups – owned by Republic)
- Crowdcube (European startups)
This is a good option for:
- people who want to invest small amounts ($100) into startups
- people who are just starting to invest in startups
This is a bad option for:
- people whose primary reason they are investing is to make money – crowdfunding platforms still have an adverse selection (they don’t see the best startups)
- people who want to invest alongside top venture capital firms
- people who want to build personal relationships with the founders of the startups they invest in
- people who expect annual updates from the startups they invest in
6. Secondary Market
Open to: Accredited Investors
The secondary market is a way for investors to buy shares in a startup from other investors. Only the top ~250 startups worldwide have enough demand from investors to warrant listing shares on a secondary market. A lot of these deals are completed offline. Still, some companies are starting to build products around secondary market investing, listed below, as it has grown in popularity since the best startups are waiting longer and longer to go public, and venture capital firms need to distribute returns to their LPs.
The most popular platforms for secondary market investing:
This is a good option for:
- people who want to invest in late-stage startups close to going public
- people who are investing more than $100,000 annually in startups
This is a bad option for:
- people who are investing less than $100,000 annually in startups
FAQ
What investment contracts will I see when investing in private startups?
- SAFE – the right to obtain equity at a future date if the startup sells shares in a future financing round. Commonly used by Y Combinator startups and startups in San Francisco for their first round of funding.
- Convertible Note – an unsecured loan that converts to equity, usually in conjunction with a future financing round. Commonly used by startups outside of San Francisco for their first round of funding.
- Priced Round – investors buy shares in the startup at a set price, the pre-money valuation. Commonly used by startups for their first institutional round from venture capitalists.
Accredited investor vs. non-accredited investor
An individual qualifies as an accredited investor based on wealth or measures of financial sophistication set by the US Securities and Exchange Commission (SEC) if they meet any of the following requirements:
Wealth & income
- Net worth over $1 million, excluding the primary residence (individually or combined with a partner).
- Income over $200,000 (individually) or $300,000 (combined with a partner) in each of the prior two years.
Financial sophistication
- Directors, Executive Officers, or General Partners (GP) of the company selling the securities.
- Any “family client” of a “family office” that qualifies as an accredited investor.
- For investments in a private fund, “knowledgeable employees” of the fund.
What’s the easiest way to start investing in startups?
If you’re an accredited investor, my number one recommendation to friends is to join a bunch of AngelList Syndicates (my recommendations here) and make small $1,000 investments into startups. By just reading the investor memos, you start to understand better how investors think about each opportunity and how they sell it to other investors. By reading many of these, you’ll develop your thesis regarding what you’re looking for and want to watch out for when evaluating a startup investment opportunity.
If you’re not an accredited investor, my number one recommendation would be crowdfunding – it’s your only option. Make an investor account on each of the top platforms, Wefunder, Republic, and StartEngine, and start to read the startup offerings. Look at the lead investor, or the person who helped set the terms, and follow people who look credible. Since crowdfunding platforms have a lot of adverse selection, I’d recommend making a couple of small $100 investments just to get your feet wet before looking at other ways to invest.
How much money should I invest in startups?
Startups are a risky asset class – treat it as a socially good lottery ticket. Only invest what you’re willing to lose.
What do I do after I invest in the startups?
If you’re a small investor, the best thing you can usually do is stay out of the founder’s way. That means don’t email them every day or expect frequent updates. Ask if you can be added to their investor update list and if you see something that you are capable of helping with (giving product feedback, recommending the product to customers, amplifying the startup’s social media posts, referring a friend to work there), then try your best to help.
