The risks and opportunities of investing in startups on equity crowdfunding platforms.
Topics covered include:
- Why do individual investors now have more access to startup investments
- What has been the historical performance of venture capital funds
- How most startups fail, leaving only a few startups to offset portfolio losses
- What factors to consider when deciding on which startups to invest
- Why do startups have so many different share classes
- What platforms are available for individuals to invest in startups
- Why indexing by investing in every credible startup deal can lead to better performance than hand-selecting a few startups
Squaring Venture Capital Valuations with Reality by Will Gornall and Ilya A. Strebulaev
How Do Venture Capitalists Make Decisions? by Paul A. Gompers, Will Gornall, Steven N. Kaplan, and Ilya A. Strebulaev
What Are SPACs and Should You Invest in Them?—Money For the Rest of Us
First Quarter 2021 Private Capital Quarterly Review—Fund Evaluation Group
Fourth Quarter 2020 Private Capital Quarterly Review—Fund Evaluation Group
The Pervasive, Head-Scratching, Risk-Exploding Problem With Venture Capital by Kamal Hassan, Monisha Varadan, and Claudia Zeisberger
Venture Outcomes are Even More Skewed Than You Think by Seth Levine—VC Adventure
Venture Returns With Abe Othman of AngelList by Collin West—Kauffman Fellows
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253: Are IPOs the New Ponzi Scheme?
321: How to Analyze Complex Investments
Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today’s episode, 350. It’s titled “Should you invest in startups on equity crowdfunding platforms?”
Changes in the Startup Investing World
I recently got an email from a new member of Money For the Rest of Us Plus. He wrote “Recently I was made aware of another investment option that intrigued me. This is getting a piece of investments into startup businesses via investment platforms like AngelList, SeedInvest, WeFunder, and Republic. I know this is a very risky investment arm, but I believe it is as risky relative to cryptocurrency. What do you think about allocating 5% to 10% of your portfolio into multiple startups (let’s say ten) via AngelList, for example, as an alternative to cryptocurrency?”
Historically, investing in startups was limited to institutional investors and very high net worth individuals. They mostly did it via venture capital funds, but in May 2016 the Title III of the JOBS Act outlined a way that private companies could raise up to 5 million dollars from all U.S. investors. And with that change in law, that has led to a number of new platforms that individuals can invest in startups businesses, just like big institutional investors. Some of these platforms require investors to be accredited, which means they have an annual income of over $200,000 or have a net worth, not including the primary residence, of a million dollars or more. Now, however, some of these platforms don’t require individuals to be accredited, and we’ll look at some of the criteria for that in a few minutes.
Venture capital has been a successful strategy. Since the late 1970s, 43% of initial public offerings in the U.S. were backed by venture capital funds. So they started out as early investors, and then through subsequent rounds, and eventually the company went public and the stock became available to all investors via a stock exchange.
Typically, the company was private for about eight years. Now, those periods extend longer than that. This was a topic we discussed back in episode 253, “Are IPOs the new Ponzi scheme?”, as startup companies stay private for well over a decade or more. And then when they went public, oftentimes they still hadn’t figured out a profitable business model.
In the past year or so, numerous private companies have gone public via combinations with special-purpose acquisition companies, or SPACs. Just this year there have been 70 new business combinations announced by SPACs, more than the 60 or so from last year. And there have been an additional 152 business combinations announced that haven’t closed yet. As individuals, should we invest in startups via some of these new platforms? And is it as risky as cryptocurrency?
Where Startups Fit on the Risk Spectrum
Last week I mentioned the risk framework introduced by Ashvin Chhabra, where he divided risk into personal risk, and we protect against that personal risk by having assets that will allow us to maintain our standard of living, cash, our home, annuities, insurance. Then there was market risk. Assets that we own to maintain our lifestyle, to keep pace with inflation, such as stocks and bonds. The third bucket is aspirational risk—assets which if they are successful, will allow us to reach a different lifestyle, to upgrade our lifestyle, to become wealthy. Cryptocurrency fits into that, but so does startup investing, venture capital investing.
I’ve been involved in startups and venture capital for over 20 years. As an advisor, I assisted clients in allocating assets to venture capital funds, I co-headed our firm’s direct alternative research team in which we research venture capital funds, and eventually put together private capital funds of funds, where we chose the underlying venture capital funds and combined them with other funds. I have been an investor in all five of those funds.
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