4 Things to Consider Before Investing in Other Entrepreneurs
A few months ago, in May, the government finally allowed the average person to become an angel investor. This change was known as Title IV of the JOBS Act. Technically speaking, it allowed “unaccredited investors” -- that is, individuals who have less than $1 million in assets, earn no more than $200,000 a year and are not professional investors -- to participate in crowdfunding campaigns in exchange for equity in a company. Maybe you’ve already done this, or at least have thought about doing it.
Related: Getting Started With Angel Investing
Is it a good move? That depends. You might be able to put money into the next Facebook…but the chances are low. My fear is that inexperienced investors will more likely bet the farm and lose everything. Now, hey, I know how entrepreneurs think: The greater the risk, the more potential for enormous returns. A lot of VCs think that way, too. But there’s a smart way to go about it. Before you jump into an investment, consider a few methods used by the private equity world to increase your odds.
Limit the size of your investment.
Many big institutional investors allocate no more than 10 percent of their assets to VC funds. Do the same with your personal “angel fund.” The other 90 percent? Keep that in a well-diversified and appropriately allocated portfolio of stocks, bonds and cash.
Many private equity funds will look at more than 1,000 investment opportunities in a year but give money to only five of them. Proper vetting is critical and takes time. So whether you’re investing $5,000 or $5 million, don’t jump at the first deal you see. Do your homework, and be ready to say no.
Hedge your bet.
Private equity funds will invest in, say, 30 companies, knowing most won’t pay out -- but betting one or two will hit big. You should play the odds as well, even if all you have is $25,000 to invest. Build a portfolio of at least five investments, and count on losing your money on one or more of them.
If you lose, claim it.
If you’re looking to win big by gambling on a few early-stage deals, your odds are worse than the ones you’ll find in Vegas. (I’m not kidding.) But high risks aside, there is one silver lining to losing money on these investments: Those losses may become an ordinary income deduction on next year’s taxes. That’s not the ideal outcome, but this is one place where our tax code can help mitigate the pain.