1st Time Investor in Startups and Other Private Businesses

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Does Investing Have to be Scary?

We were asked to write this post by several individuals who had questions.

Investing doesn’t have to be scary.  I got into this space to help create a world for my community, my kids and other people’s kids that didn’t exist.  I want them as members of the community to literally be able to invest in private businesses and startups in their community.  This involves educating a large part of the population that has never had access or didn’t know they had other options outside of the publicly traded stocks, mutual funds, etc. listed in their brokerage and/or retirement accounts.

Most individuals I meet are at least curious about this new world that has recently been enabled by new investing laws and regulations.  So this post is devoted to all of you who are new to the early stage / private business investing process and would like to learn more.

Not Investment Advice The following is not meant to be investment advice or an exhaustive list of what to look for in an investment.  It is also not meant to be a detailed list of what all of the terms mean.  Rather it is meant to be a starting point for someone new to the process of investing in startups and private businesses to help point them to where they can get answers to their questions.

Is this safe?
We partnered with a Broker-Dealer platform to form Localstake NC, because as a Broker-Dealer, they are regulated by the SEC and FINRA.

  • Localstake facilitates the raise process in a way that complies with all laws.
  • As an experienced and trusted partner, they’ve helped multiple businesses successfully complete offerings.
  • All investor information is safely stored on their platform and transactions are conducted digitally (e.g. signing deal docs, transferring investment dollars, etc.) …meaning it’s very similar to your other brokerage accounts.
While investing in this way carries a high degree of risk, including the possible loss of all capital, it also comes with the potential benefits of the following:
  • Potentially higher returns than the stock market
  • Opportunity to invest directly where you live
  • A method to diversify

Never invest more than you are willing to lose and seek guidance from your tax and/or legal counsel to help determine if this type of investing is right for you.

What am I investing in?
You’re investing in a small team’s ability to form and execute a business plan.

  • Get to know the team through the profiles they create online
  • Others in the community may know the team members and can provide recommendations
  • Look at the ‘traction points’ for what the team has already achieved
  • See what their plan is for the future

Don’t expect to see a business’s “secret sauce”… those items that are strategic to its growth that if revealed would provide a competitive disadvantage.  However, businesses are required to list factual data and many state their plans or projections with assumptions.

Additionally, Broker-Dealer platforms such as Localstake NC are required to perform background checks on directors, officers, key management team members and anyone with significant ownership.  While this doesn’t provide a gauge on a team’s ability to execute, it does provide a level of vetting.

How will a business become profitable?
This is a loaded question.  Let’s start with the following.

  • What kind of product or service is the business selling?
  • Who are they selling “it” to?  
  • Are people buying because of a need or a want?
  • What is the price point they are selling “it” at?
  • How many “its” do they have to sell in order to become profitable?

The good part to investors is that all of these data points and more are typically answered by the business’s team on the investment campaign profile they create on Localstake NC.  If they don’t have an answer to your question listed in the campaign material, no problem.  You can ask it directly in the Discussion board which gives the team you are considering investing in a place to answer the question, and the answer can also be seen by other potential investors.

What is my potential return?

Businesses can offer equity or debt.  Why a founding team chose one or the other to offer is typically a matter of what will pass the Broker-Dealer’s Underwriting legitimacy test as well as a business’s strategy, philosophy and type of business.
Equity is used so that you own a piece of the company.  There is little to no obligation for a company to owe you anything as an investor if the company fails.  You are investing in the long term growth of the company (shared risk) which if they take off, could be big to you as an investor.  For example, if you invest at a $5M valuation, and then the business is sold at a $50M valuation at exit, you get a 10X return on investment or ROI. (less any administrative fees)
  • Common or Preferred Shares/Units – Direct ownership upon purchase.
  • Convertible Note – A type of debt which can convert to equity at a discount.
  • Simple Agreement for Future Equity (SAFE) – You invest in the company now, and your investment will be converted into equity at a discounted valuation when a future equity raise occurs.
Debt is typically used to fund short term (usually 1 to 5 year) needs.  However, there are exceptions to this which are beyond the scope of this article.  When you loan the company money via a debt offering, you aren’t listed on the cap table and don’t own a piece of the company.  You are agreeing to provide capital and expect to be paid back regularly over time.
  • Loans/Promissory Note – e.g. invest and receive X% interest (typically 8-15%) annually, principal and interest is repaid monthly or quarterly
  • Revenue Share – return paid as a percentage of actual business revenue e.g. invest $X and receive 1.5X your investment over Y years (typically 3-5) paid monthly or quarterly
  • Convertible Note – Typically pays any principal + interest at the end of the note’s term (1-3 years is usual) usually upon investor request OR this interest is added to your principal investment amount upon conversion to equity (e.g. conversion event = usually upon the note’s term, sale of company, subsequent raise of $X amount, etc.)

Startups or High Growth Ventures typically issue Equity.  Main Street Businesses typically issue Debt.

So where does that leave us?

We’re here to help.  We enjoy providing education to new and existing investors.  Investing doesn’t have to be a daunting process.
We know we couldn’t answer everything in this post, but we appreciate answering questions.  Check out our Invest and Get Funded pages as well as other areas of our site.  Feel free to send us your questions, [email protected].  Your question and our answer may end up on our site with your permission, so by asking, you’re helping out the next person too.