What are the advantages and disadvantages of investing in startups?

QuietGrowth - Advantages and Disadvantages Investing in Startups

A startup can be a public company or a private company. It is not common for an early-stage startup to be a public company, though there are a large number of early-stage and late-stage startups that have gone public in various stock exchanges across the world. Current and future performance of some public companies is analysed to a great extent by many people and firms, while the remaining public companies are analysed to a lesser extent. The market price of the public stock reflects this future expectation on that stock. So, the below discussion is on startups that are not public companies.

The main advantages of investing in startups that are not public companies:

  • You get to benefit from the tremendous upside if the startup succeeds. The return on investment can be superlative at the event of startup exit.
  • If your investment is significant, you can negotiate with the board to get some insider information on company performance. This privilege will help you to observe better the industry in which the startup is operating.
  • If you are part of some notable startup exits resulting in a high multiple of your investment, your reputation as a startup investor is burnished. You can make use of this reputation capital for personal gain in many different ways.
  • Depending on the jurisdiction the startup operates from or the location where you live, you may avail certain tax benefits for the amount you invest in early-stage startups. Please consult your tax adviser for more details.

The main disadvantages of investing in startups that are not public companies:

  • You will be taking up a high amount of risk, especially with early-stage startups. There is a high chance that an early-stage startup might fail. There is a good chance that a later-stage startup might fail. There is a good chance that a well-performing later-stage startup might not be able to get the desired exit, resulting in a mediocre return on investment for an investor.
  • You will not enjoy liquidity for your investment. You will not be able to sell your shares until the startup gets an exit. Some startups allow the secondary sale of shares of early shareholders, but those are few and happen when specific stars are aligned.
  • In some jurisdictions, you need to be an accredited investor to invest in startups. This restriction can be overcome if the startup that you are interested in to invest opts for the crowdsourcing model for one of its funding rounds.
  • It is suggested that you invest in startups only with your ‘play money’. It is a ‘discretionary fund’ of a size that they are comfortable. The amount in this discretionary fund can go towards investing in risky opportunities in which they believe and understand. Not all people can afford to have play money, and even if you can set aside some play money, it might be less than the minimum amount required to invest in a startup.
  • Your investment portfolio can become less diversified.
  • Unless you are a limited partner of a venture capital firm or a large family office, you may not get access to invest in later-stage startups. If you intend to invest directly in a startup, you usually can do it only during one of the seed funding rounds before the Series A funding round of that startup.
  • It is challenging to be aware of the opportunities to invest in specific startups. Getting access to the startup fundraising deal flow is not easy. Those who enjoy the advantage of quality deal flow will get the opportunity to invest in the most desirable startups.
  • You need to devote considerable time to research before investing in a specific startup.

Startup investing is not easy. So, after setting aside your play money for investing in startups, you may invest for the long-term in a diversified portfolio. Digital advice firms such as QuietGrowth help you to invest for the long-term.

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