After reading my last post Equity Crowdfunding post you might be interested in putting money into a small scrappy start up company. ‘Angel Investing’ is the term used to describe rich individuals that seed or provide the early stage funds for start up companies to grow big enough to attain financial stability. Angels are often the first stage of financing after ‘family & friends’ and help bridge the gap before Venture Capital funding. They are essential to the start up ecosystem and equity crowdfunding is generating more interest in the space. ‘Angels’ are often retired entrepreneurs providing advice and connection to the (often) younger management team. Angels like advising and staying in touch with the entrepreneurial community without the day to day operational stresses of a new venture. Angel Investing is also quite social, ‘Angel Forums’ in different cities allow for co-investing in several companies to diversify the risk while also sharing information.
In September 2013 the SEC removed the ban on public solicitation, this opens up Angel Investing from a murky old boys club to the modern transparent web portal. Portfolio managers often mention that a small percentage of your assets should be held in high risk high reward areas. It doesn’t take a rocket scientist to realize many people made money on Facebook, and several other of the recent social media darlings. Equity CrowdFunding provides you the opportunity to place your bet on the next hot company and ride the wave. Although ‘Retail Crowdfunding’ or equity crowdfunding for the everyday man will only be legal after the SEC finalizes Title 3 of the JOBS act I’d recommend all investors stay up to speed around the changes in securities laws. Lower ‘buy ins’ via portals also allow investors to spread the risk. Previously if an angel group wanted to place a 200,000 dollar investment into a start up they’d have to pull from their small geographic member base. With crowdfunding portals the minimum investment is as low as 1000 dollars on many sites. This makes it easier to acquire shares in 12-15 companies with 10% of your overall portfolio.
Am I advocating for you stay away from bonds, GICs, and the conventional stock market? No, but if you are putting away 10,000 dollars a year consider placing 10% in a start up company or two. The bulk of your portfolio will probably grow slowly with a 2-8% return per annum, but that $1000 will either end up as nothing or (hopefully) an amazing return. Venture Capitalists state that out of every 10 investments they might get 1 ‘home run’. This ONE investment provides a 20-30X return, 50% of the companies will go bankrupt, a few ‘zombie’ investments will neither grow nor die and the remaining will return a modest 2-3X return. Furthermore you can’t retract your investment at any time, early stage companies are very illiquid, meaning that you can’t easily sell your shares. Recently sites including SecondMarket have sprung up, but start up shares are still very difficult to liquidate until an IPO or buyout. Expect any investment in a growing venture to be locked up for minimum 2-3 years. Although you will no longer need to be a ‘sophisticated investor’ to invest via web portals by mid 2014 in the United States you should be a ‘knowledgeable investor’.
Start ups are dreams with explosive potential and you can’t compare them to a traditional business. They won’t have cash flow, salaries will initially be low or non existent on the balance sheet, and they often pivot after starting into something very different. If you aren’t prepared to receive investor updates about your ice cream machine company that just pivoted into a hipster beard cooling device or something equally random the start up scene might not be your ideal investment market.