Start ups usually lose money while they’re getting established. You have build the product, hire the team, and then get customers. So, you lose money for several years — which is why Angel Investors, venture capital firms, etc. exist.
Take a novel medication, for example. You aren’t making a dime until you get FDA (in the U.S.) approval and so you do fundraising rounds to hire staff, do clinical trials, scale up manufacturing, etc. Then, once you get approved, you (ideally) make a fortune.
Ideally for the early stage investors (and staff that was partially compensated in shares), you “make an exit” — get bought by a bigger company or go public. And that’s when everyone gets paid. If a company stays private forever, you repay early investors with dividends or share buybacks (or everyone is just sort of fucked and waiting for an exit). Shares in a private company have value on paper but no store takes SpaceX shares as a payment method.
In the United States, you have to be an “accredited investor” to invest in early stage start ups. To be an accredited investor, you either have to be wealthy — $1 million in wealth (not counting your house) or have income over $250,000 for 2 consecutive years — or pass some of the tests generally required to be a banker (like the Series 7 exam).
That’s what makes start ups different from a normal small business. If you open a bar or restaurant, you generally get a loan from a bank and are profitable when you open. If you want to raise rounds and lose money for years, only “accredited investors” can invest. Basically, the government bans people who aren’t aware of the risks or able to take the L that often comes from investing in risky start ups. You have to prove you’ll be fine if the company fails (or that you know what you’re getting into).
I feel like I’ve heard about friends and parents chipping in small amounts to startups, is that a recent change or is there a limit on how much you can invest?
Friends and parents certainly can chip in but they usually get bought out for nothing or their shares are diluted to basically nothing when bigger money comes in.
They probably were using “start up” wrong but there’s no police force hunting down people who lied about being non-accredited investors. You just have to sign a standard form that says you’re an accredited investor and it basically just means you can’t sue anyone if you lose your money.
If a company fails, they might still have some value. In the medical company example I used, maybe they fail Phase III safety trials and don’t get approved. So, they sell all their laptops and beakers or whatever. You don’t get to sue anyone for shenanigans1 if you lied about being an accredited investor.
1 Shenanigans is not a legal term but don’t invest in risky start ups with founders you don’t know if you aren’t able to absorb the loss
Start ups usually lose money while they’re getting established. You have build the product, hire the team, and then get customers. So, you lose money for several years — which is why Angel Investors, venture capital firms, etc. exist.
Take a novel medication, for example. You aren’t making a dime until you get FDA (in the U.S.) approval and so you do fundraising rounds to hire staff, do clinical trials, scale up manufacturing, etc. Then, once you get approved, you (ideally) make a fortune.
Ideally for the early stage investors (and staff that was partially compensated in shares), you “make an exit” — get bought by a bigger company or go public. And that’s when everyone gets paid. If a company stays private forever, you repay early investors with dividends or share buybacks (or everyone is just sort of fucked and waiting for an exit). Shares in a private company have value on paper but no store takes SpaceX shares as a payment method.
In the United States, you have to be an “accredited investor” to invest in early stage start ups. To be an accredited investor, you either have to be wealthy — $1 million in wealth (not counting your house) or have income over $250,000 for 2 consecutive years — or pass some of the tests generally required to be a banker (like the Series 7 exam).
That’s what makes start ups different from a normal small business. If you open a bar or restaurant, you generally get a loan from a bank and are profitable when you open. If you want to raise rounds and lose money for years, only “accredited investors” can invest. Basically, the government bans people who aren’t aware of the risks or able to take the L that often comes from investing in risky start ups. You have to prove you’ll be fine if the company fails (or that you know what you’re getting into).
I feel like I’ve heard about friends and parents chipping in small amounts to startups, is that a recent change or is there a limit on how much you can invest?
Friends and parents certainly can chip in but they usually get bought out for nothing or their shares are diluted to basically nothing when bigger money comes in.
They probably were using “start up” wrong but there’s no police force hunting down people who lied about being non-accredited investors. You just have to sign a standard form that says you’re an accredited investor and it basically just means you can’t sue anyone if you lose your money.
If a company fails, they might still have some value. In the medical company example I used, maybe they fail Phase III safety trials and don’t get approved. So, they sell all their laptops and beakers or whatever. You don’t get to sue anyone for shenanigans1 if you lied about being an accredited investor.
1 Shenanigans is not a legal term but don’t invest in risky start ups with founders you don’t know if you aren’t able to absorb the loss
This is true for pretty much any business. You should expect to be unprofitable for at least a year.