In the past, investing in startups was an opportunity reserved for those with significant venture capital. With the passage of the Jumpstart Our Business Startups (JOBS) Act in 2012, times have changed for both investors and startups. Startups can utilize crowdfunding platforms, like MicroVentures, to raise capital for their business, and investors are able to enjoy access to early-stage investment opportunities without accreditation or significant overhead capital.
Understanding the Risks
With just over 50% of startups failing in the first four years, there’s no doubt that investing in startups is a risky business. That said, there are plenty of reasons why you should think about investing in startups. If you’re considering adding startup investments to your investment portfolio, here are a few benefits to consider if you’re on the fence:
1. Portfolio Diversification
With any investment, there will be risk involved. You will hear horror stories of investors putting all their eggs into one risky basket, only to end up losing it all. Luckily, there are steps investors can take to avoid this kind of significant loss, and it starts with portfolio diversification.
Portfolio diversification aims to balance financial risk with financial gain. Although startup investments are risky by nature, adding them to a portfolio of traditional assets, like stocks or bonds, may actually reduce overall portfolio risk by ensuring parts of the portfolio are not too similar. Because startups’ returns are typically uncorrelated with these industries, they are less likely to experience the same market fluctuations that may be experienced across assets in the same industry. Increasing portfolio exposure to an asset class not correlated to traditional asset classes can be an effective defensive strategy. Optimally, uncorrelated assets will post gains in those market conditions where stocks and bonds struggle.
2. Getting in Early
One of the simplest reasons investors may want to consider backing startups is the potential to get in early on the next big idea. With the introduction of crowdfunding platforms, the barriers to becoming an early-stage investor are much lower than they have been in the past, with some investment minimums beginning at just $100. The typically lower requirement for overhead capital combined with the upside potential of an exit may make for a potentially high-reward scenario for investors.
3. Efficiency in Numbers
The theory of the “Wisdom of Crowds,” or collective intelligence, makes the claim that when it comes to decision making, prediction, and problem solving, large groups of people have an advantage over any one individual. In general, a sum of information from a large group of people may lead to better decision making than an individual could reach independently.
This same theory of collective intelligence can apply to crowdfunding. While there are no guarantees, this efficiency in numbers means that typically, good crowdfunding campaigns rise to the top and get funded, while bad campaigns do not.
4. Job Creation
There is no question that startups support the economy through job creation. In fact, according to the Bureau of Labor Statistics, startups gained 1.7 million jobs from March 2016 to March 2017, compared to just 336,000 jobs from older companies – a 406% difference.
In addition to job creation, the BLS found that startups are usually less affected by economic downturns than older companies. As older companies close or cut jobs during economic downturns, startups are more resilient, oftentimes continuing to create jobs.
For investors who are looking to support the economy and job creation, investing in startups is a great way to make a very direct and tangible impact.
5. Powering the Future
Whether it be non-profits, green tech, sustainability, or medical advancements, innovations that will power our future are often born of startups. For investors that want to see their money make a difference, impact investing is a strategy that allows investors to become a part of something bigger than themselves by backing the innovations and technological advancements that matter the most to them. Unlike grants, impact investing offers a win-win situation for investors and successful businesses: potentially life-changing ideas get the funding they need, while investors receive a return on their investment.
For a first-time startup investor, it’s important to understand that investing in startups is an especially risky venture and is much different than investing in more traditional assets like publicly traded stocks or bonds. That said, with the risks come the potential for high reward.
Whether you’re looking to diversify your portfolio with alternative assets, want to get in on the next revolutionary technology, would like to do your part to support the economy, or simply aspire to make a difference in the world, there are plenty of compelling reasons for investors to allocate a small percentage of their investment portfolio to startup investments.
Want to begin investing in startups today? Check out our current list of active Regulation Crowdfunding raises.