For the first time, in almost a century, anyone can invest in private companies. With the public stock market prices at an all-time high and bond yields historically low, startups offer an exciting new way to diversify your investment portfolio.
- Companies used to create much of their value after selling shares on the public stock market.
- Because of technology and new regulations, companies can now raise most of the capital they need from private investors. They don’t have as immediate of a need as they once did.
- New rules in effect May 16, 2016 allow anyone over the age of 18 to purchase shares in private companies.
Why Do Private Companies Have the Potential to Yield Sufficient Returns?
People invest money because they want to see their money grow. That used to be fairly easy. People could take little risk but get a decent yield by purchasing bonds, or they could take a little more risk and get a better yield by investing in well-established companies on the stock market.
Because of regulations like the 2012 JOBS Act, which enables companies to remain private while soliciting investors online, startups can remain private as their businesses grow.
In 2014, there were 40 private companies valued over $1 billion. The average age of companies when they go public has been steadily climbing. What does that mean for an investor?
If companies stay private longer, their stock does not enter the public market, which means investors don’t have the opportunity to purchase shares as the company grows.
If you purchase shares in a company for $10,000 worth 1% of the company when it’s valued at $1 million, if the company grows to be worth $100 million, your shares will be worth $1 million.
On the other hand, if a company is already valued at $1 billion when it finally sells shares on the public market, how much will that company grow? The potential for growing as a percentage of market capitalization is inherently reduced.
Those are oversimplified examples - the road in startup finance involves a lot more twists and turns. And there’s no guarantee that a company will succeed at all - it can fail completely and be worth absolutely nothing. But those examples illustrate the benefits of investing.
The Return Potential in Startup Investing
Potential investment opportunities in startups used to be restricted to wealthy people and institutions - people who make over $200,000 a year or with a net worth over $1 million.
Lawmakers put those restrictions in place to shield the average person from the risks associated with startup investing. Startups are companies with little or no operating history, few customers, little market share, and potentially early-stage technology that may not take off.
Few startups succeed to their next funding rounds, let alone to IPO, and regulators wanted to restrict those investments to people who could afford to absorb the risk.
However, Congress saw the potential in crowdfunding sites like Indiegogo and Kickstarter, and realized that the public should have access to startup investments to help spur growth and to give the average investor access to those potential returns.
Title III of the JOBS Act, also known as Regulation CF, opened private investments to the general public while keeping protections in place by limiting how much people could invest.
Under Regulation CF, people making under $100,000 per year can invest the greater of $2,000, or 5% of the less of income or net worth, per year. People making between $100,000 and $200,000 a year may invest 10% of the less of their income or net worth.
Thanks to the new equity crowdfunding rules, anyone can take advantage of the open startup marketplace and support a company they believe in. Unlike crowdfunding sites like Indiegogo or Kickstarter, crowd investors can have a share of a company’s future success.