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You don't need a whole lot of money to begin angel investing. In fact, today we're going to share everything you need to start investing in small startup companies right now.
By investing in small startup companies, or angel investing, you gain the opportunity for massive returns on a stock long before it starts trading publicly.
Not only do you not need millions of dollars to start, but you also don't need a ton of know-how. The Jumpstart Our Business Startups (JOBS) Act of 2012 made angel investing more affordable and accessible for everyone. And in a moment, we'll show you how to get started with just $50.
Jeff Bezos had 22 "angels" to help him start Amazon.com Inc. (NASDAQ: AMZN) in the mid-1990s. They invested $50,000 each in exchange for a 1% stake in the company. As you can probably guess, the value of that one-time investment soared. Today, it's worth $8.5 billion, or a gain of 17-million percent.
Of course, that doesn't happen with every investment. But startup investing is a way to build wealth that's different from trading public stocks. It gives you a chance at those higher percentage gains.
So here's how angel investing works, with some strategies to help you manage your risk investing in small startup companies.
What Is Angel Investing?
The term "angel investor" was first used to describe people who would fund struggling theater productions. It was later expanded to include startup investors.
Specifically, today's angel investors come in before a company gets to the point of going public.
Angel investors generally step in after a company has received initial investments from friends and family, but before larger venture capital firms enter the picture. In general, many of these businesses have values of $5 million or less at this stage.
When you buy shares in a company that trades on the New York Stock Exchange or the Nasdaq, you are only one out of a million or more investors, and you also get just one vote per share. But, as an early-stage investor, you get more pull than that.
While you may not get to direct how a company operates, you will get a larger stake by investing early in small startups. In general, angel investing also gets you more access to company insiders than you would receive with blue-chip stocks.
However, these benefits also come with some risk. But if you are willing to shoulder some additional risk to be an angel investor, you also have the potential for mind-blowing returns.
Here's how that risk can be limited…
Managing Risk When Investing in Small Startup Companies
Angel investing is certainly riskier than buying shares in a mid-cap or blue-chip stock. The trade-off is the potential for bigger gains.
Because of this risk, you need to carefully consider how much you are willing to invest and use an allocation method such as the 50-40-10 model. With this model, you'd limit your investment in small startups to just 10% of your overall portfolio.
You also don't need to hit it big with every stock or even every five investments. Instead of looking for steady returns on your portfolio as you normally would, you only need one or two of your investments to deliver a big return.
That's why it's better to spread your investments across several startups instead of placing all your trust in just one or two. With this mindset, you can invest in 10 startups, see nine of them fail miserably, and still be incredibly profitable. It only takes one company that turns into the next Amazon to transform your investment into life-changing wealth.
But this is going to be tough to achieve if you don't know how or when to cash out…
Securing Your Profits from an Angel Investment
It's not uncommon for startups to dilute their share structures. But there's a common misconception that this hurts angel investors.
Yes, dilution might reduce your percentage stake in the company. But when done for the right reason, it is going to increase the value of your shares.
Assume you owned 10% of a company and another angel comes in with a massive investment. This might reduce your percentage stake in the company, but the dollar value of the company just went up significantly. In other words, it's better to own a smaller stake in a company that is going somewhere than a large stake in one that is about to shutter its doors.
Your stake as an angel investor will be more worthwhile once some or all of that money is in your pocket. This means that you will need some sort of an exit point to sell your shares and realize all or some of your gains.
In many cases, the liquidity event for angel investors is an initial public offering (IPO). The company finally decides to go public, and angel investors are the primary beneficiaries of this system.
Here, you have the opportunity to sell your shares. And, if you genuinely believe in the company, you may wish to hold onto some of them for the long haul (think of Amazon).
Another potential exit point is an acquisition. Big corporations snap up disruptive startups left and right and absorb them into their operations.
If yours is one of those lucky companies, you can experience a major payday by cashing out at this point.
Now that you know the basics of angel investing, you only to need to find the right companies to get started.
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