What are some basics to know about startup investing?
Individuals who invest in startups are called angel investors (see Angel Investing), whereas firms that are set up to invest in startups are called Venture Capital firms, or VCs (see Venture Capital). Conventionally, only a small number of institutional investors such as select endowment funds, family offices, fund of funds, and pension funds have been able to invest in top VC firms. As the world’s leading online VC, FundersClub lowers the barrier to diversify one's portfolio to include the types of investments traditionally targeted by top VC firms, and uniquely is open to both individual and institutional investors.
An investor that invests in a startup is buying a portion of the startup, with the intent to share in the possible upside were that startup to later become successful. Financial returns are realized by the investor when a liquidity event occurs, such as a secondary sale of stock, an acquisition, or an IPO. These events, and thus receiving back investment capital, can take a long time (e.g. 4-7 years is typical), and may not occur at all if the company is not successful, often resulting in a write-off of the entire investment.
Sophisticated startup investors who are seeking a financial gain generally expect the majority of the startups in their portfolio to become total or partial losses, with the minority of the startups in their portfolio returning such a high profit so as to both make up for the portfolio losers as well as to generate an overall portfolio profit. As implied above, startup investing is generally known to be high risk, high reward. As a result, diversification is a strategy employed by many professional startup investors to help balance wins and losses (see Diversification).
While FundersClub encourages investors to be profit-seeking, not all startup investors are purely seeking a financial gain and also pursue startup investing for other benefits (see Why do people want to get involved with startup investing?). These include supporting innovation, supporting founders, and staying current with new trends.
Investors seeking to profit from startup investing generally seek an overall portfolio return that beats comparable public market benchmarks. One such benchmark is the Russell 2000 index, which measures the performance of the small-cap segment of the U.S. equity universe and which has averaged an annual return of about 9.2% over the past decade. The S&P 500 is another benchmark index some investors compare to, which has averaged an annual return of about 9.1% over the last century. The Kauffman Foundation, a well-known institutional investor in VC funds, seeks a premium of at least 1.3x to such public market benchmarks, or at least about 12%. VC firms target annual returns in the range of 20-30% or more, though the median return of the VC industry is generally in the single digits. Thus, a profit-seeking investor would best benefit from investing in the very best startups rather than the entire asset class of startups or venture capital. This is why FundersClub puts such an intense focus on curation and screening, listing only the top 2% of startups it reviews for investment.
Finally, startup investments and private equity generally make up only a portion of most professional investors’ overall investment portfolio, which may also include public equities, real estate, natural resources, and other asset classes.
