In the past five years, we have seen an explosive growth in the private market. Only, this growth was not fueled by venture capitalists but rather, retail investors. In 2016, congress passed the JOBS ACT which allowed non-accredited investors to begin investing in startups through equity crowdfunding platforms such as Wefunder and Start Engine.
In the last three years alone, there has been a 40% growth in the global crowdfunding market. It’s easy to understand why investing in startups for equity is so attractive. While there remains significant risk of failure, it only takes one successful startup to return a 20x, 50x, or even a 300x return multiple on an investment. In order to increase the likelihood of success, it’s important to understand these 5 crucial things before investing in a startup.
One of the first questions you should ask yourself before investing in a startup is, “Does this product have growth potential?” The market size is the first crucial indicator in confirming the growth viability of a product.
If it is a physical product that is localized to its region, global reach and market size will be limited. If a startup has created the first “Alligator Deterrent/Sunscreen” for golfers, then there isn’t going to be much reach outside of the southeast United States.
Once you have established a product has a potential market size, you need to ensure that market would be willing to adopt the product. To understand if a product has market validation, it needs to be solving a wide-spread problem.
A great example of this is AirBnB.
AirBnB noticed that there were 17,000 weekly, temporary housing listings on Craigslist in San Francisco and New York alone, leading them to validate that the tourist market needed more options when it came to vacancy and capacity than hotel listings could offer.
So, now you have established that there is a sizeable market with a problem to solve. Now, it comes down to “Can this product take a share of that market?”
Most likely, there is already a competitor doing what this product does. So, it really comes down to “Is this product unique and can it solve the problem more efficiently than the leading competitor?” If so, it could probably steal some of that market share.
Any startup is going to go through growing pains. They are going to encounter burnout, legal challenges, and disharmony amongst its team members. However, if the team starts out with a clear focus, a passion for their product, and the flexibility to pivot when needed, the product will have a greater likelihood of succeeding.
Take Tyler Hayes, CEO of Atomic Limb, the first mind-controlled bionic arm. His personal tragedy gave him a purpose and passion that he is trying to fulfill through his startup.
Once he has established his core purpose, he built a team that is constructed of the expertise needed to bring it to life. The team is built from top design engineers from Apple, Johns Hopkins, Intel and more. Having this type of history and background on the team allows the product to move forward in a meaningful direction.
This is a no-brainer. If the startup has already taken on millions of dollars in debt and profitability is simply a pipe dream at this point, then it most likely will not succeed. It’s normal for a lot of startups to have some amount of debt at the outset of their venture, but if the debt is poorly structured and inappropriately spent such as spending on marketing before the product is finished, that is a sign of mismanagement.
The financial disclosure should include more than the historical results of the operation such as what the short and mid-term expenses will be and any liquidity and capital resources available.
You should really understand the two levels of risk when it comes to investing in startups: The general risk of investing in startups and the specific risk of the startup you are investing in.
Even with the growth of crowdfunding platforms, the failure risk of startups is significant. Nearly 9 in 10 startups will fail. They will fail for a multitude of reasons, but the primary reasons are the ones we have listed above. They may have miscalculated market size, validation, lacked focus or mismanaged investments. However, it only takes one solid investment in a startup to make a major return on investment. They are often equated to calculated lottery tickets.
The other level of risk is specific to the product and the go-to-market strategy. Questions you may ask yourself are “What are the potential legal hurdles?” “Is this product subject to strict regulation or scrutiny from government agencies?” The more potential hurdles the startup must jump, the riskier the investment becomes.
Finally, finding the right equity crowdfunding platform is almost as important as the startup investment itself. There are more crowdfunding platforms coming on the market each year with no signs of slowing down. Everything from crowdfunding real estate to crowdfunding litigation is available to retail investors, so make sure you are taking the time to understand which platform is right for you.
There are at least five important criteria to look at before deciding on the right equity crowdfunding platform:
Fortunately, at Wealthplicity, we have ranked some of the top crowdfunding platforms on the market. We will be writing reviews on all the major platforms soon but click here to get started.
Wefunder is an excellent Crowdfunding platforms that allows non-accredited investors the ability to invest in startups in the private market. WeFunder allows investors to invest in a variety of categories, including; Debt, Equity, B Corps and even the local community.
Startup investors, non-accredited investors, risk tolerantGet Wefunder Read Our Full Review Pros & Cons
Access to investing in startups is an incredible investment for the retail investor. Even though there are significant risks to investing in startups, your chance of success greatly increases if you understand some crucial criteria. As always, perform your own research and fully prepare yourself before any investment.