So you want to invest in venture capital? Congratulations! It can be extremely fulfilling, rewarding, and financially lucrative. Some of the biggest, most successful companies today would never have been able to get off the ground if it weren’t for investors who bought into their vision.
But for as much opportunity as it presents, investing in startup companies is not without its challenges and caveats –– despite what Hollywood may portray. There are certain legal requirements to become an investor. And more importantly, investors have to go in with the right mindset. After all, your money will likely be tied up for a while and there’s a chance you may never get it back at all.
Requirements to be an accredited investor
To invest in private equity, an individual must first meet at least one of the federal requirements to become an accredited investor:
1. Have either an individual or joint net worth of $1 million excluding the value of your primary home.
2. Have an individual annual income exceeding $200,000 or a joint income exceeding $300,000 for the last two years, with an expectation to match or exceed it in the current year.
While those are the two ways for an individual to meet the requirements to become an accredited investor, a private organization can become accredited if it has at least $5 million in total assets.
Investors need to have financial security
But not all people who meet the requirements to become accredited investors should. This is where you have to really check your gut and evaluate your individual financial situation.
While every VC firm will differ, the minimum investment at Canal Partners is $50,000, with the average investment at $100,000. You have to be ok with that money being tied up for a long-time, even when the investment is successful. Most of the time, even in a best-case scenario, it will take at least 3-5 years for a liquidation event to occur. However, there are cases where the investment might take more than 10 years to be realized –– this is particularly true if you are investing in funds. Investing in private equity isn’t a get-rich-quick scheme. You have to be comfortable with the fact that you likely won’t see your money again for a long time.
That’s not to mention that even with the most carefully vetted, highly sourced investments, there is always a chance that something will go wrong. Unforeseen changes in the global economy, a natural disaster, or, like we’ve seen recently, a pandemic could hit and completely change the growth trajectory of the company. If the company has to fold, you’d be left with nothing.
A good private equity firm will do their due diligence to minimize the risk, but if losing $50,000 to $100,000 isn’t something you can financially withstand, it may be better to wait to invest.
Investors need to know what they are signing up for
There’s a reason why firms like Canal Partners tend to prefer to work with investors who have prior experience investing in private equity or venture capital. Those types of investors are more likely to understand what they are getting themselves into.
The first thing investors have to understand is that investing in private equity isn’t an active investment. You won’t have any control over how the money is spent or decisions the company makes. Everything is out of your hands.
Investors also have to understand the non-liquidity of the investment. It isn’t like the stock market. You can’t sell off your shares whenever you want. That money is tied up, and it might be for a long time.
Finally, investors have to understand that there are going to be up-and-downs, and it is important to stay calm and patient. No good has ever come from getting anxious and angry over every little swing.
Choosing the right private equity firm
If you haven’t been scared off by now and are still enthusiastic about investing in venture capital, then it is important to make sure you put your money in the right hands. While there are no sure things, private equity firms that have an experienced team, a strong track record of success, and put their own money into deals is a good way to minimize your risk and maximize your returns.