This week, with the second article in this 3-part series, we will continue our discussion of startup portfolio management by focusing on your investor strategy. Last week, we covered the first step of creating a portfolio plan and developed a hypothetical plan to invest $10,000 in 25 companies over 3 to 5 years. The next step is to develop an investor strategy, which is all about how you will put your money to work. It’s important to decide this before jumping into what specific investments you want to make.
Key Questions for a Public Equity Investor Strategy
As an analogy, let’s first look at the factors involved in developing an investor strategy for publicly-traded equity (aka stocks). Once you have decided to put capital into public stocks, you still need to decide how you will put your money to work. Key questions include:
- How much capital do you have to invest? This will affect the options that are available to you. Hedge funds, private wealth management, and separately managed accounts are typically only available to high net worth individuals.
- What is your level of investment experience and the time you are willing to commit? This will affect your decision to use a financial advisor, robo advisor, or manage your stock portfolio yourself.
- Which investment vehicle(s) are the best fit for you? Your preferences regarding risk/reward, diversification, and fees are important factors in deciding whether mutual funds, Exchange Traded Funds (ETFs), or individual stocks are a good fit.
Key Questions for a Start-up Investor Strategy
Your startup investor strategy involves some of the same questions, such as total capital and time commitment, but the implications are different.
- Are you an accredited or non-accredited investor? Historically, the private investing world has been limited to accredited investors, who make up only 3% of US investors. The JOBS Act of 2012 opened up opportunities for non-accredited investors. However, many startup investment vehicles are still limited to accredited investors.
- How much capital do you have to invest, in total and per investment? Many accredited investment options have high minimums of $25,000 to $100,000. There are accredited vehicles that reduce the per investment minimum to $1,000 to $10,000. Non-accredited options have the lowest minimums starting from $10 to $100.
- How much of your personal time are you willing to commit to startup investing? Nearly all options require some amount of time commitment as there are no private market equivalents of financial advisors, mutual funds, or ETFs (yet).
- What is your level of industry, technological, financial, and investing knowledge? Since investments are offered on a “buyer-beware” basis, you need to be able to understand the industry, technology, founders’ experience, and business model of a startup — or being willing to learn them.
- What, if any, non-financial goals do you have related to startup investing? Other than making a return on your investment, you may like the idea of supporting entrepreneurs, growing your professional network, or learning more about certain industries or technologies.
Common ways to invest in startups
Now that we understand some of the key questions and factors to our investor strategy, let’s look at the most common investment vehicles.
Venture Funds (or Angel Funds)
This is the traditional way of investing in startups. With this approach, investors make a single investment in a “fund” managed by the partners of a Venture Capital firm (VC). The VCs then use that pooled money to invest in dozens of startups. Investors get a professional management team and diversification with zero time commitment and no experience required. Of course, that also means you typically don’t get direct exposure to the portfolio companies or entrepreneurs.
In exchange for the convenience, VCs typically charge 2% annual management fee, plus 20% of profits returned by the fund. However, to be eligible to invest in a VC or angel fund you have to be an accredited investor and willing to make a commitment in the six to seven figure range. This high cost makes VC and angel funds inaccessible to most individual investors.
Angel Syndicates (or Angel Groups)
An angel syndicate is simply a group of individual investors that pool their capital to invest in startups. This allows a syndicate to meet the minimum investment requirement that its members couldn’t meet individually. It also allows the company or entrepreneur to deal with one investor entity and point of contact. Some syndicates have a dedicated team of professionals that source deals, perform due diligence, and invest alongside its members. These syndicates may charge some level of fees and carried interest. There are also syndicates that are member-managed, where members volunteer their time and expertise toward deal sourcing and due diligence.
Typically, deals are done offline (meaning through email, attachments or Dropbox, Docusign, etc) rather than through an online portal or app. Syndicate members get access to company pitch decks, webinars and Q&A with founders, and due diligence materials. They also get to individually decide which companies they will invest in. This requires a meaningful time commitment, but it offers the opportunity to lean on the syndicate for due diligence, learn from more experienced syndicate members, and get more access to entrepreneurs and company updates. Unfortunately, you must be an accredited investor to join a syndicate and deal minimums are usually $1,000 to $10,000.
Shares sold by a company directly to investors are called “primary” shares. Shares sold between investors or others are called “secondary” shares. The shares are the same either way. The only difference is who is selling them.
Secondary shares are typically only available for large, later-stage companies that have shown meaningful success. Often these are “unicorns” that have less risk than a seed stage company (though not risk-free). However, the higher valuation reduces the return potential. Unfortunately, again, most secondary shares are limited to accredited investors and minimums can range from $1,000 to $100,000.
Direct Investing — Sourcing your own deals
Investing directly in a startup on your own is the most time-intensive and highest risk option. Founders usually want at least a $25,000 check. They may also prefer individual investors that can offer added value through connections, industry knowledge, or other expertise.
These types of deals are typically done offline. The investors are 100% responsible for figuring out due diligence, as the company may not be required to file disclosures with the SEC. While technically you do not have to be an accredited investor to make a direct investment, it is common for companies (or their lawyers) to only accept accredited investors as that reduces and simplifies their disclosure requirements.
Crowd Investing Platforms
Crowd investing platforms are open to accredited and non-accredited investors alike and offer low minimums of $10 to $100 per deal, making them accessible to the vast majority of investors.
In some ways, crowd investing platforms operate similar to Angel syndicates. They allow small investors to aggregate their funds to make a meaningful investment in a company. Working through the online platform makes it convenient for both entrepreneurs and investors. In this sense, crowd investing has increased access and efficiency of startup financing for all parties.
Crowd investing sites source the deals and perform screening and due diligence before posting the deal on their platform. This saves investors a lot of time and ensures all deals are legitimate companies and investments. But, unlike an Angel syndicate, a crowd investing platform is not making an investment recommendation. And most likely, it is not investing alongside you. So you still need to do your own due diligence and come to your own independent decision.
One of the big advantages of crowd investing over other startup investment vehicles is the disclosure requirements. In addition to platform-specific due diligence, every company raising money through a crowd investing platform must file a Form C “Offering Statement” with the SEC at the time of the campaign (most campaign pages will have a direct link to the Form C). In addition, companies have to file a Form C-AR “Annual Report” each year thereafter. Both of these filings provide an overview of business activity, financial results, management and board, and company ownership. Until now, it was rare to get this level of reporting from early stage companies.
If you are early in your startup investing career, then I recommend making angel syndicates and crowd investing platforms a central part of your investor strategy. These methods will allow you to develop your investing skills while also learning about the companies, technology, and industries you are investing in.
Crowd investing platforms are a particularly great way to get started, even if you are an accredited investor. The high-volume of deals and low minimums provide a good environment to implement a portfolio plan and learn early lessons at a low cost. The platform-provided screening takes some of the workload off of investors and reduces the risk of a suspect deal. That said, the “campaign” page on a crowd investing platform is the company’s pitch and marketing materials. It is not a substitute for independent due diligence.
Crowd investing platforms are also where much of the innovation in the private investing world is happening. As an example, Republic and SeedInvest both launched auto-invest style features that make it easier to build a diversified portfolio based on your budget and investment preferences. I expect crowd investing platforms to be the drivers behind future innovations that makes startup investing more accessible and manageable for everyone.
Ready to take the next step? Check out the next article in this series on developing an investment thesis.
With over 54 FINRA regulated online funding portals and over 300 companies actively raising at any point in time, crowd investing can still be a lot of work. That’s where KingsCrowd can help out, as we aggregate deals across all 54 platforms and provide independent ratings and analysis on Top Deals, as well as founder profiles and industry research that can help supplement your due diligence. Be sure to check out KingsCrowd’s tools and resources that can help get you started on your investor journey.
About: Mike cozart
Mike is a Director of Product Management and part-time start-up investor. Mike started his career as an investment banking analyst and venture capital associate before taking on general management and product management roles with Amazon and Axon Enterprise. He earned an MBA from Columbia Business School in New York City, a BA in Economics from The University of Texas at Austin, and a BS in Geographic Information Science from Texas A&M University at Corpus Christi.