The last decade has seen the rise of the startup, both in the financial and popular press. We all know the success stories; Uber, AirBnB, Twitter, and others have gone from nothing to multi-billion dollar valuations in extremely short periods. And they were funded, in part, by angel investors who gained immensely from their success.

Because of this attention, and with new regulations like the JOBS Act and the rise of platforms, like MicroVentures, that facilitate equity crowdfunding and angel investing online, more people than ever are thinking about investing in startups.

While startup investing is risky, it also provides the possibility for outsized returns (anywhere from five to 100 times your initial investment) when compared to other asset classes. Depending on certain factors, it could be a great idea to put some portion of your portfolio into high-risk assets like startups. But before you do, there are three major factors you need to consider to make sure start-up investing is appropriate for you.

1. Risk: What is your risk tolerance? Can you afford to lose money?

Public markets are diverse so it is relatively easier to find investment vehicles that match your risk tolerance. You can invest in bonds, treasuries, blue-chip companies with long histories and other more stable investments, and possibly alongside IPOs and other companies that are more speculative.

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Startups are a whole different breed. The winners tend to win big, but most fail. And when they fail, you almost never get any money back. It's gone, along with the company.

Before you get into this kind of investing, you must ask some questions: Are you a conservative investor? Do you want to minimize risk and see some kind of underlying asset backing an investment? Or are you the type of person who’s willing to lose it all?

If you’re on the conservative end of the spectrum, startup investing is NOT for you. Startup investing is only right for people who want to take big risks (and potentially lose their money) in exchange for the admittedly low probability of huge rewards.

That said, even though startups require a high risk tolerance, you can mitigate some of the downside. Early-stage companies with just an idea carry the biggest risk. But you can also find companies with an idea and a prototype (or something else tangible), or even a clear path to revenue, or a seasoned executive team with a history of finding ways to generate business.

Bill Clark

The other way to reduce risk is by not betting on just one company. Spread your money around. Well-known “angel” investor Ron Conway used a method dubbed “spray and pray” that’s still popular. He would invest in hundreds of early-stage companies and then make follow-on investments in the ones that began to gain traction. Conway didn’t just invest in every startup that came his way; he made intelligent decisions based on factors including how unique the idea was and if the management team could make it work.

You may not have the level of sophistication and network that Conway has, but with the rise of crowdfunding and angel investing platforms, building your own venture capital portfolio is now truly possible.

These online platforms allow companies to more easily raise money from larger groups of people. You can now invest in 10 or more companies with $50,000 of available capital. And when three out of four startups are destined to fail, you want to put your money into as many different companies as possible to maximize your chances of success. This ability to diversify risk across multiple startups is unique to these platforms, and can't be replicated by just investing in small businesses your friends start.

The great thing about angel investing is that one or two winners could pay off all of your other investments and then some. With a portfolio of only two or three investments, the likelihood of finding these big winners drops significantly.

Time: When do you need your money?

Startups are much less liquid than other types of investments. Generally, the only way you're going to see a return on your investment is after the company has a liquidity event or exit. To figure how long that might take, you need to understand the exit strategy of the startup in which you’re investing. Do the founders want to go for an IPO? That could take 10- to 15 years. Do they want to build traction and get acquired by a bigger company? Or do they want to keep the company private and run it themselves?

Not only do you need to understand the exit strategy, but you also have to determine if that strategy is feasible. If the startup wants to be acquired, are there companies for whom it makes strategic sense to make the acquisition?

All of this comes back to the question of when you would like to see a return on your money. Is it two or three years or seven years or more? If you need this money sooner, look at late-stage companies on the secondary market that are in the pre-IPO phase. At MicroVentures, we saw investors generate returns investing in Yelp YELP, -4.02% , Facebook, FB, -0.89% and Twitter TWTR, +2.03% on our platform during their run-ups to IPO. Nowadays there are several companies which could repeat that success: Uber, airbnb, Box, and Dropbox to name a few.

But generally, the only money you should invest in startups is money you don’t need for at least the next five- to seven years, and ideally a decade or more. If you need your money to produce significant returns within a short time-frame, and with low risk, you shouldn’t be investing in startups at all.

3. Expertise: Do you have the experience to evaluate companies and markets?

The best startup investors apply their own operational business experiences to make investment choices. The more time you’ve spent in a startup or running your own business, or even working for a company, the better you will understand the aspects of business a startup needs to master. You will also be better-equipped to identify whether the startup is, in fact, mastering them.

If you are a more cautious investor who needs more data before making an investment decision, you might begin with startups in industries where you have worked the longest or spent the most time. When dealing with an industry you understand, it’s much easier to answer questions like: Does this company have a good idea that can actually work? Do they have a business plan that makes sense? And does the team have the necessary skills and experience to execute on that plan?

But if you’re looking at a company that’s outside your wheelhouse, you probably don’t know how to assess it accurately. The idea may sound amazing and have world-changing potential, but without the background to truly analyze the market you’re not playing to your strengths.

That doesn’t mean you shouldn’t invest in those types of companies. If you have properly diversified investments in multiple startups, strategically you should be able to handle the risk by putting more money into the startups from industries you understand.

This is only the beginning of your journey. There’s still plenty more to consider. Ultimately, investing in startups can be overwhelming. Besides offering risky bets on companies, many platforms make the situation worse by providing little or no guidance for investors. They might have exciting offerings — but that excitement can mask potentially unsound deals. On the other hand, typical discount brokerages are not able to give their investors access to trendy and lucrative opportunities like Facebook or Twitter until those deals are available to all investors via an IPO.

Crowdfunding is going to change a lot in the future. If you’ve got the right appetite for risk and for playing the long game, and you bring expertise to the table, then startup investing could be worth exploring.

Bill Clark is president and founder of MicroVentures, an equity crowdfunding platform that allows investors to invest as little as $5,000 in curated startup companies. He has more than a decade of management experience in the credit risk management and financial services industry. Follow him on Twitter at @austinbillc.

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