Startups
Highlights
Good For
High risk, High return
Time Horizon
Long (10+ years)
Earnings from
Acquisition or IPO
Liquidity
Illiquid
Roughly 90% of startup companies will not make it to year 10. But when a startup does go public or is acquired, investors can achieve returns of 1000% or more. Endowment funds typically allocate about 20% to 40%, and high net worth individuals allocate over 20% of their portfolios to private equity. Private equity funds invest in a large number of promising startups in order to diversify their risk exposure to any one company.
Did you Know
Oculus started its journey with a crowdfunding campaign. In 2014, it was purchased by Facebook for $2 billion in 2014.
Peloton started making its indoor exercise bike after raising $307,332 in a 2013 crowd-funding campaign. It’s now valued at $28 billion and traded on the stock market.
Uber's seed round netted them $510,000 with a valuation of just $3.86 million. A number of Angels invested with amounts as low as $5,000 into this round. This investment would now be worth north of $25 million.
Considerations
Allocating 5% to private growth companies could increase the returns of a traditional portfolio by 12% and lower volatility.
Angel investors manage to 2.6x their money on average. Assuming that the average time to exit is five years, 2.6x equates to 21.1% annualized returns.
There are few asset classes that offer the homerun potential of startup investments.
You’re funding the future! Startup investing provides the opportunity to invest in innovation and to feel real ownership in the companies that you invest in.
Reasons to Invest
Investing in startups is extremely high risk. It's one of very few investments that could potentially 100x your money, but in many cases, your investment will go to zero.
In order to properly diversify and manage risk, you want to spread your investment out over at least 5 or 10 different startups. This usually requires a fairly sizable initial investment.
Most retail investors don't have access to startup investments. This is changing thanks to crowdfunding platforms, but if you're looking to gain access to rooms full of VCs and angel investors, that will take time and money.
Drawbacks
How You’re Taxed
Capital Gains
Income Tax
Profits earned from investing in startups are taxed like stocks. Investors are subject to short-term capital gains when selling investments held for less than a year, which are taxed at ordinary income tax rates. Long-term capital gains are applicable when investments are held for a year or more with tax rates ranging from 0% to 20%, depending on your total taxable income.