What to Consider Before Investing in a Startup

Thinking of investing in a startup or other privately held business? Here’s what to consider before making an investment.

While funding private businesses may be a tempting avenue to try to boost your investment returns, be careful: Investing in privately held businesses, particularly startups and early-stage businesses, is generally far riskier than investing in publicly traded companies.

Here are three things to consider before making a private equity investment:

1. Research the Company and Founding Team

If you hear about a business investment opportunity online or through an acquaintance, approach it cautiously. Do your research and learn as much as you can about it. Search for news coverage of the business and talk to company leaders. Ideally, the management team has a proven track record of starting and running successful businesses. Ask questions: How will the business generate revenue? What successes has it had to date? Have major angel investment groups or venture capitalists invested in the firm? If you have any doubts or can’t get satisfactory answers to your questions, you may want to walk away. Consider that some crowdfunding sites may not fully vet startup campaigns, so it’s a good idea to find out what level of due diligence a platform conducts before making investments online.

2. Don’t Let Emotions Trump Judgment

If you’re investing through a crowdfunding site, it can be easy to get pulled in by a great story. Some of the most popular crowdfunding campaigns are those with an emotional tug — a startup with an inspirational story or creative business plan. While it’s easy to get caught up in the moment, base your investment decisions on sound financial reasoning. Take time to evaluate the product or service and consider how the investment fits into your overall financial plan.

3. Understand the Risks

Devoting a small portion of your overall portfolio to funding startups or crowdfunding campaigns may be rewarding, but don’t overdo it. Remember that early-stage businesses have a high rate of failure. Generally, a good rule of thumb to follow is less than 20 percent of a portfolio should be devoted to high-risk investments such as private equity.

Contact a Wealth Advisor for help determining how private equity investments fit into your overall financial strategy.