Seattle is experiencing a tech boom second only to that in San Francisco, creating a new generation of startups led by ambitious founders. On average, these startups receive $800,000 to $850,000 in funding — much of it from local investors.
These local investors, some motivated by the desire to support the Seattle economy and to contribute to an operation that is close to home, others encouraged by the success stories of startups covered by the media and hopeful of a chance to capitalize on the tech industry, often do plenty of research on the startup before making the decision on which young company to help fund.
And yet deciding to invest in a startup is so much more than having enough capital on hand to make a meaningful investment and choosing the lucky winner. Startups are volatile businesses, often highly valued but with opaque performance metrics and little real profit. Investing in a startup carries significant risk, in ways that could affect the financial safety of the investor beyond just the investment itself.
In fact, the key to wisely and safely — or as safely as possible — investing in a young company is to do so only after the investor has first ensured that his or her own financial responsibilities and well-being are properly cared for.
Investors looking to invest in a startup have to be more farsighted in terms of their personal and family finances because of how risky such an investment can be. They should have a fully holistic view of their long-term wealth planning as insulation against possible negative impacts of the investment. In other words, investors should approach wealth management no differently from how they approach a potential business venture — they must treat their personal wealth situation as they would a potential investment by covering all the bases. While investors may be busy investing in the future success of others, they also need to ensure that they are adequately covered as well.
This point is particularly relevant because while investments in startups can lead to impressive returns, investors pay for that in greatly reduced liquidity.
It is hard to pay for anything with company values that essentially live on paper. So until that liquidity comes about — when the company goes public or when an investor cashes in his or her stake — the monetary value of the company is technically hypothetical. This is why it’s important to ensure that major expenses are handled before investing in a startup, as that money may be tied up for longer or in more complicated ways than originally expected. If a potential investor has annual payments to make, such as retirement savings, life insurance or education funding, it is essential that there are still enough liquid assets on hand to cover those expenses.
An effective startup investor knows to delegate responsibility and have metrics in place to measure progress in business growth, and the individual’s own personal finance strategy should be no different. For those who can tolerate the risk, well-informed investments in startups should only be made after other financial bases are covered. Working with a knowledgeable adviser and going in prepared can help ensure that, should the startup succeed, the investor’s financial situation is greatly enhanced — and even if it does not, the investor’s financial situation is still well covered.
Mary Justice is Washington state market leader for the Private Client Reserve of U.S. Bank in Seattle. Reach her at firstname.lastname@example.org or 206.344.3688.