How investing in startups works | Equity 101 lesson 9 - YouTube

There’s no one right way to build your financial  future. If you had talked to me a decade ago and  

asked me, “How do you invest in startups?” I  would’ve said that you probably have to have  

an amazing network, you have to  have gone to certain schools.

Well, guess what? I’m a normal person with  a normal job. And I’m proud to say that I  

am a startup investor. So today we’re going  to demystify the whole process of investing  

in startups. You just need to know who can  invest and how you do it. So let’s get started.

The big thing to know is that private  company shares are super different from  

public company shares like the kind that you  would buy on the stock market. Public company  

shares are registered with the Securities and  Exchange Commission, which is a federal agency.  

And if that sounds serious, it is. This means that  public companies have to report their financials  

and a whole range of other information that would  be material to a buyer or seller of the shares.  

What is material information? Anything that’s  meaningful that helps you make a decision.

So if you’re looking for information about public  companies, you can find that information pretty  

easily on the internet. You can find their  quarterly earnings, their annual earnings,  

and all of this information is intended  to do one thing: Protect shareholders.

So if you own shares of a public company,  

or if you’re thinking about buying shares of  let’s say Google or Apple, you have access  

to all of their financial information at any  time. And guess what that does? It puts you on  

a level playing field with everybody else.  Whether you’re a big institutional investor  

or just sitting at home on your computer, you  have access to basically the same information.

But with private companies, it’s way different.  A private company doesn’t have to release any  

of that information to the public. So what does  that mean? It means that in private companies  

comes with a lot less information—and  as a result, a lot more risk.

So in order to invest in a  private company like a startup,  

you have to meet some special criteria.  We’re going to talk about those criteria.

There are accredited investors and  there are qualified purchasers.  

Both of these are terms that are set by  the Securities and Exchange Commission.  

And what they basically mean is that you have to  have a certain level of financial sophistication  

which allows you to purchase securities  that are not registered with the SEC.  

And that’s because you are assumed to be  sophisticated enough to understand the  

heightened risk involved with investing in private  companies, where you have very little information.

So in other words, if you are  one of these two things—an  

accredited investor or a qualified purchaser—then  

you are legally qualified to take on the  additional risk of investing in private companies.

So what’s the difference between an accredited  investor and a qualified purchaser? Well,  

an accredited investor is typically more  relevant to individuals. It means that you,  

as an individual, meet certain lifestyle and  educational criteria, like your income, your net  

worth, or your education. Whereas a qualified  purchaser is usually more relevant for funds,  

institutional investors,  family offices, or companies.  

And it’s less about their assets  and more about their investments.

So a simple way of putting this is if you  want to be an accredited investor, you have to  

pass a financial exam, or have a certain  net worth, or have a certain income. And if  

you want to be a qualified purchaser, then you  have to be investing a large amount of money.

So let’s talk about the criteria for each  one. What is an accredited investor? This is  

someone who meets a specific set of criteria  pertaining to their assets, their education,  

and their lifestyle. So what does all that  mean? It usually means that your income,  

or your net worth, or your  education meet a certain criteria.

Let’s talk specifics. So if Iris  wants to be an accredited investor,  

she has to tick at least one of these  boxes. As of today, as an individual,  

Iris has to have earned income of at least  $200,000 per year for the last two years.  

And she has to have a reasonable expectation that  she’ll earn that much again in the coming year.

And remember, right now Iris is filing her taxes  as single, but let’s say she has a big life event  

and she gets married. Well great—that actually  changes her situation a little bit. She’s going  

to still need to meet an income threshold,  but now that income threshold goes up. So she  

and her partner will need to make $300,000 a year  jointly to qualify to be an accredited investor.

Another way Iris can become accredited is through  her net worth. So if you thought it was hard to  

make $200,000 a year, get this: She or her family  will qualify if they have a net worth of over a  

million dollars. But here’s the catch: It cannot  include her primary residence, meaning the place  

where she lives. So if Iris saved her money and  she bought a house, she cannot include that in the  

value of her net worth. Her million dollars needs  to be independent of the value of her residence.

So those are two of the three pathways towards  accreditation, but let’s say Iris doesn’t meet  

either of these criteria. That’s OK. She  can still become an accredited investor  

by passing a financial exam and holding a  specific license, like a Series 7, a Series 82,  

or a Series 65, which are issued by FINRA.  She can also invest through a trust,  

but those rules start to get a little more  complicated, so we’ll cut it off there.

The big thing to take away: Becoming an accredited  investor is typically all about meeting certain  

metrics for your assets in your everyday life. And  the criteria for who can be an accredited investor  

have changed over time. So make sure to  check the latest guidelines from the SEC.

And what these metrics indicate is that  you are able to take on extra risk,  

the extra risk of investing in a private company  that does not report its financials to the public.  

And whether it’s your education,  your income, or your net worth,  

you’re able to communicate that you are able to  withstand the ups and downs of startup investing.

So, there are many different types of investors  who are qualified to invest in startups. We just  

talked about accredited investors. So in terms  of risk, if a normal, everyday investor is here,  

an accredited investor is up here. Now  we’re going to talk about a third level  

of qualification, which is up here.  And that’s our qualified purchaser.

Now, you can imagine that if the road  to becoming an accredited investor  

means you have to make a good bit of money,  have a high net worth, or pass a financial exam,  

the road to becoming a qualified  purchaser is even harder.

Being an accredited investor is typically all  about assets, income, net worth, or in some cases,  

qualifications. But being a qualified purchaser is  all about investments. It’s all about purchasing  

power, which is why the criteria to be  a qualified purchaser is a lot higher.

So a qualified purchaser is an entity—could  be an individual, a family office, a business,  

an endowment, a foundation, or a pension—that has  a significant amount of capital. That capital is  

their purchasing power. They have the potential  to buy tens to hundreds of millions of dollars  

worth of investments. They are at an entirely  different level than our accredited investor.

So if we’re talking about an individual  like Iris or a family office, if they have  

five million dollars of investable capital,  they would qualify as a qualified purchaser.

Now let’s say Iris owns a million dollars in real  estate, again, not counting her primary residence.  

And she also has five million  dollars in a retirement account.  

One million plus five million equals six  million. She would be a qualified purchaser.  

She meets that minimum threshold  to become a qualified purchaser.

Now let’s look at another scenario. Let’s say  Iris is managing a larger entity, like a trust  

that’s owned by other qualified purchasers. And  they have invested at least 25 million dollars  

in private capital. This would also  mean that Iris is a qualified purchaser.

You can be a qualified purchaser, but  what you really need to remember is  

these measures and these definitions  exist to protect us normal people so  

that we don’t take on too much risk  that we’re not yet prepared for.

The upside to investing in startups, once you’re  able to do it, is not only can the startup have  

a huge return for you as an individual or  as an entity—you can also help create jobs,  

create new technology, et cetera. And that is the  kind of risk that we want people to take. And so  

it’s super important to have more pathways for  people to participate in this startup ecosystem.

And at the end of the day, if  you want to invest in startups,  

the SEC wants to make sure that you’re able  to take that risk on. Say you were one of  

the early investors in Amazon or Google before  the company went public. As the company grew,  

it must have been thrilling to watch the  value of the equity grow along with it.

And that type of opportunity is happening all the  time today. You join the company as an investor  

or an early employee, and you watch it  grow. And you’re along for that ride  

as they build new products, hire  new people, expand globally.  

And along with that growth, the value  of your equity is growing along with it.