How To Invest In A Tech Startup
The IT industry's dynamic startup culture is one of its many assets.
Tech startups span from freshly formed private enterprises to public corporations that have just gone public. These tiny businesses are typically in the early stages of creation or execution, and they are looking for venture capitalists and angel investors to help them market their goods.
Meta Platforms (NASDAQ: FB), Twitter (NYSE: TWTR), Airbnb (NASDAQ: ABNB), Snap (NYSE: SNAP), Snowflake (NYSE: SNOW), and DoorDash are just a few of the most successful digital firms of the last decade (NYSE: DASH).
While the technology industry is very unpredictable, and investing in tech startups may be a dangerous undertaking, investing in a firm early on can pay off monetarily if investors choose the right horse.
For example, someone who bought 589 shares of Snap, the parent company of Snapchat, when it went public in March 2017 would have put down an initial investment of US$10,013, with each share worth US$17. That investment would be worth US$36,924 on March 12, 2021, representing a 38.5 percent compound annual growth rate.
However, it's worth noting that the IT industry is very volatile; on March 8, 2022, that identical investment would be worth half as much (US$18,730). There are several tech companies to pick from in every aspect of the IT business.
So much so that deciding whether firms are worth the risk may be tough. The Investing News Network explains all you need to know about investing in tech companies, from what to look for to how to get started.
What Qualities To Look For In A Tech Company
The hard fact of startup financing in any sector is that 90% of startups fail within ten years. Investors, on the other hand, may reduce the inherent risk by doing thorough due diligence. Investors should look for firms with a strong management team, a clear sense of identity, and the ability to dominate in their specialized market sector.
Because the digital sector is so fast-paced, it's critical for businesses to have a clear vision of who they are, who they want to serve, and who they are competing against. Technology is a complex ecosystem in which many firms collaborate to generate incredible final products. Companies without a well-defined identity may generate upheaval, but not in a positive way.
However, digital firms need more than simply a strong sense of self. They'll also need a big picture of how they'll affect their target market. This potential for market leadership is an important element to consider for individuals wanting to invest in IT businesses.
The first and finest firm in a certain field has a distinct edge over its rivals, making it an intriguing investment prospect. Companies with a novel value offer that targets a new market segment or an unmet demand in an existing one may become market leaders in the future. As part of their due diligence, investors should evaluate management.
Look for teams made up of people who have a track record of developing successful businesses and who can adapt the ideas they've utilized in the past to their present firm. A well-rounded team will include specialists in finance, marketing, and operations, and will demonstrate unique and comprehensive experience that offers the company a competitive advantage.
Knowing The Tech Market Is Necessary For Investing In Tech Firms
Investors must first study the technological industry in order to determine if a new firm is actually tackling a lucrative yet underserved segment.
According to Investopedia, the tech sector includes “consumer goods like personal computers, mobile devices, wearable technology, home appliances, (and) televisions,” as well as “the manufacturing of electronics, creation of software, computers, or products and services relating to information technology.”
It also includes B2B goods and services in the areas of corporate software, logistics system management, and the gathering, preservation, and analysis of crucial data. All of these B2C and B2B products and services are so important to the global economy that it's simple to understand why the technology industry is one of the most appealing investment industries.
Social media, blockchain, cloud-based computing, fintech, mobile applications, the internet of things (IoT), artificial intelligence (AI), medical devices, gaming, and cybersecurity have all seen significant development in recent years.
The cloud-based everything-as-a-service industry is expected to do particularly strongly. The worldwide cloud computing industry is expected to increase at a compound annual growth rate of 16.3 percent between 2021 and 2026, reaching over US$950 billion, according to ReportLinker.
Innovation and broad use of internet-of-things-as-a-service, software-as-a-service, and platform-as-a-service technologies will fuel this expansion. Meanwhile, according to Fortune Company Insights, sales in the AI section of the tech industry will reach US$360.36 billion by 2028, as “industries around the world are quickly implementing artificial intelligence into their processes to better business operations and consumer experience.”
Another multibillion-dollar sector is fintech. According to Market Data Forecasts, this sector of the IT industry will be worth roughly $324 billion by 2026. Autonomous cars, natural language processing, bioinformatics, and 3D printing are some of the other top developing technologies to keep an eye on in the near future.
Investing In A Tech Business Before It Becomes Public
Individuals who invest in a tech startup before it reaches the IPO stage get ownership, or equity, in the firm, which may subsequently be sold for a profit if it goes public or is bought by a bigger corporation. Much of a tech company's value is developed privately before it goes public. I
n a blog article, Andy Reed, director of Propel(x), discusses how “private markets, widely classed as Alternative Assets,' may deliver returns that would otherwise be difficult to discover in publicly listed corporations.” But how can investors gain a leg up on the competition? Angel clubs or online platforms for early-stage investors, such as AngelList and Propel, are recommended by the Wall Street Journal (x).
Online platforms, according to investing expert Tim Lemke, allow investors to diversify their portfolios while also feeling good about supporting firms they believe in. SeedInvest, Wefunder, Republic (established by AngelList alumni), and MicroVentures are among the startups he advises (an early founder of many top companies, including Twitter).
Venture Capital Funds For IT Startups
The lack of liquidity is the major disadvantage of investing in a private firm. Unlike publicly listed stock, private firm equity cannot be bought or sold readily. According to the Wall Street Journal, “investing in later-stage, but still young, firms via publicly listed funds that hold holdings in companies previously financed by venture capitalists” is another way to get into the digital startup market. These venture capital funds provide firms that aren't publicly traded exposure.
Participating In IPOs For IT Startups
IPOs allow investors to invest in a tech firm as soon as it begins trading on the open market. “IPOs are frequently reduced to assure sales,” according to Investopedia, “which makes them even more appealing, particularly when they create a large number of purchasers from the initial issue.”
Until recently, many Internet businesses preferred to remain private for extended periods of time, postponing or avoiding IPOs. In recent years, though, IT businesses have been interested in going public. According to Baker McKenzie's research, worldwide IPO raises were at an all-time high in 2020 and 2021.
In terms of both volume and capital raising, the financial and technology sectors are at the top of the list. Airbnb for $3.49 billion, DoorDash for $3.37 billion, and Snowflake for $3.9 billion were three of the largest IPOs in 2020.
Rivian (NASDAQ: RIVN), Grab (NASDAQ: GRAB), and Nubank (NASDAQ: NUBAN) were among the successful technology IPOs in 2021, focusing on electric cars, ride-hailing applications, and finance (NYSE: NU).
EFTs That Invest In Technology Startups
ETFs (exchange-traded funds) is a low-cost, low-risk way to invest in tech businesses. The Invesco S&P SmallCap Information Technology ETF is for investors interested in small-cap tech businesses (NASDAQ: PSCT). PSCT is a small-cap growth index in the information technology sector that focuses on the software, internet, electronics, semiconductor, communication, and hardware areas.
While PCST's biggest holdings are more established IT firms, the Renaissance IPO ETF (ARCA: IPO) concentrates on recently listed firms. Uber Technologies (NYSE: UBER), Snowflake, Datadog (NASDAQ: DDOG), CrowdStrike Positions, and Zoom Video Communications are the top five holdings in the IPO (NASDAQ: ZM).
The First Trust US Equity Opportunities ETF is another ETF that monitors the performance of recent IPOs (ARCA: FPX). FPX also has a good mix of older firms, which helps to spread out its risk. Marvell Technology (NASDAQ: MRVL), Airbnb, Uber, Datadog, and CrowdStrike Holdings are among the companies in its portfolio.
It's difficult to provide a clear description of a startup: It might be a corporation developing a new product or service under significant uncertainty, or a company attempting to tackle an issue with no clear answer and no promise of success. To invest in a company, you used to need both money and contacts, no matter how you defined it.
This is no longer the case, and ordinary investors may now readily participate in interesting startup opportunities via crowdfunding portals. Although startup investment has the potential to be rewarding, it must be understood that it also carries significant dangers. Even if you do your homework, you might find yourself with nothing in your pocket if your business fails. Here's everything you need to get started investing in startups.
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Startup Investing Platforms
Crowdfunding portals allow regular individuals to invest in companies. Startup investing platforms maintain a list of firms and have varied minimum investment requirements. Wefunder, SeedInvest, StartEngine, and Republic are all major participants in the crowdfunding startup industry.
“Thousands of businesses seek to raise money on our platform each year, and we only accept roughly 3% of them,” says Kendrick Nguyen, CEO of Republic. The majority of the sites mentioned above allow you to invest in businesses with as little as $100, whereas SeedInvest demands at least $500.
AngelList is another popular startup funding site, however, it only accepts accredited investors with annual earnings of at least $200,000 ($300,000 if married) and a net worth of at least $1 million, excluding their principal home. On AngelList, the minimum buy-in is $1,000.
How Much Money Can You Put Into A Startup?
According to SEC standards, non-accredited investors should be informed that there may be a limit amount they may contribute in crowdfunding endeavors in any 12-month period:
- If your annual income or net worth is less than $107,000, you may invest up to $2,200 or 5% of your annual income or net worth, whichever is less.
- You may invest up to 10% of your annual income or net worth, whichever is smaller, if your annual income and net worth are equal to or more than $107,000. However, the total sum cannot exceed $107,000.
Just because you have a specific amount of money to invest in startups doesn't imply you should. According to Randy Bruns, a certified financial planner (CFP) in Naperville, Illinois, “the correct amount to allot should be no more than the investor can safely lose if the business goes bankrupt or takes an unusually lengthy period to play out.”
Experts also advise making multiple little investments in a variety of startups rather than one large investment in one. In fact, AngelList recommends that you “only invest if you have the funds to make 15-20 startup investments” in its investing rules.
This offers diversification: if you invest in five businesses, four of them will fail, but one will succeed, potentially protecting part of your money. According to AngelList, “you should anticipate your overall losses to surpass your earnings.”
Investing In Startups: How To Make Money
You engage in an investment contract with a startup when you invest via a crowdfunding platform. There are four types of investment contracts in general, each of which provides distinct opportunities to profit from your investment:
This contract handles your money as though it were a loan with interest. The contract may pay a fixed or variable return, such as two times your investment. The timing of interest payments is determined by how well the firm operates over time.
Notes That Convert
This contract is a kind of debt that turns into shares of stock when a firm achieves specified milestones, such as raising further rounds of investment. You profit from your investment when the business is sold to another company or goes public.
Later-stage businesses may allow you to purchase equity in the firm, similar to how you would with a publicly listed corporation. Just keep in mind that you won't be able to sell your startup stock. You must hang on to your shares until the business goes public or is bought by another firm in order to profit.
Successful later-stage businesses allow investors to purchase a stock that pays yearly dividends.
Why Should You Invest In Startups?
Investing in startups provides you with a front-row seat to challenges being solved and new technologies being developed.
Potential For Expansion
Large-cap companies in the S&P 500 are significantly less risky than startups, but exponential growth is rare. However, if you choose a successful company, the sky's the limit. “There's so much room for growth,” says Tom Schryver, an entrepreneur who teaches at Cornell's SC Johnson College of Business. “There is a massive multiplier effect that might be immense.” Part of what an investor would be purchasing is that.“
Belief In A Novel Concept
Because it involves entrepreneurs exploring a novel concept, startup investment may appeal to you. “People typically invest in what they want to see in the world,” says Elias Stahl, creator of HILOS, an ecologically friendly shoe manufacturer. “There is no greater chance to observe and support something you care about in the world.”
Perhaps your brother or a neighbour is launching a fantastic new product. It seems to be a novel concept, and you wish to contribute to the funding of a friend's or relative's initiative. “A lot of individuals invest in startups because they're part of a network and want to support a project they're familiar with,” adds Schryver.
A Sensation Of Accomplishment
Some investors engage in startups because they like the experience of helping someone establish a company, seeing something new come to life, learning about new sectors, or getting in on the ground floor of something interesting. “If someone is serious about doing anything, there's no replacement for getting started,” Schryver explains.
Why You Should Avoid Investing In Startups
Startup investment is not for everyone, especially those seeking minimal risk and consistent returns.
Startups Are Very Dangerous
Approximately 90% of all businesses fail due to a lack of product-market fit, marketing concerns, team troubles, or other reasons. “Total loss is a possibility,” Schryver warns. In general, startups are only a viable investment if you're willing to risk losing your whole investment. Index funds and exchange-traded funds (ETFs), or even individual equities, should account for the overwhelming bulk of your investment spending.
Startup Investments Are Risky
You could simply sell a stock you acquired today if you changed your mind about it tomorrow. On the other hand, startups are notoriously illiquid. When you invest in a company, you should plan to be committed for at least three to five years, if not longer. “While you may be able to sell via secondaries, it's not a certainty, and your investment will likely take years to develop and materialize,” says Ammar Amdani, a partner at Adapt Ventures, an early-stage venture capital company.
Results Take Time To Appear
Even if a business is successful, it may take years before you see a return on your investment. “To allow your portfolio company time to flourish, you have to be patient and have holding power,” Amdani explains.
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