Depending on how you look at it, it could be a scary time to be an investor right now — especially in the stock market.
With Russia invading Ukraine, historic levels of inflation, and the lingering effects of the pandemic, the market is going through some rough times.
In the past two months, the broad-based S&P has dropped by about 7%. And the tech-focused Nasdaq has plummeted by double that amount, or roughly 14%.
If things continue like this, it’s not difficult to imagine a scenario where stock prices drop by 25%, 50%, or even more in the coming months.
But today, I’ll show you how to turn this potential crisis into a money-making opportunity.
All you need to do is add one particular investment to your portfolio: startups.
How to Make Money in Startup Investing
When you invest in a startup, there are two main ways you can make money:
Either the startup goes public, or it gets taken over by a larger company.
But just because one of those events happens, that doesn’t necessarily mean you’ll make money. Just like with any investment, a profitable trade is based on buying low and selling high — in other words, your entry price and your exit price.
With stocks, your entry price is a company’s share price or its “market cap.”
It’s the same thing with startups, but the words are different. With startups, instead of saying “market cap,” we say “valuation,” which refers to the total value of the enterprise.
But regardless of what it’s called, basic investment rules still apply:
If you pay too high of an entry price — too high of a valuation — even if the company goes IPO or gets acquired, you still might not make money!
Losing Sleep Over This Loss
To show you what I mean, look at Casper Sleep (NYSE: CSPR).
In its last financing as a private startup, Casper — a maker of high-end mattresses and bedroom accessories — had a valuation of roughly $1.1 billion.
However, after a disastrous performance as a publicly traded stock, Casper got bought out last year for just $273 million.
So even though investors got in while the company was still private — well before the company went IPO and got taken over — they still didn’t make money on Casper.
In fact, they suffered an 80% loss!
The moral of the story is simple:
When investing in startups, you need to pay careful attention to valuation.
And here’s why this lesson is even more important today…
When Prices Come Down, Your Profits Can Go Up!
When stock market prices come down, so do startup valuations.
To show you what I mean, look at this chart from Daniel Li at Madrona Venture Group:
It might look confusing at first, but this chart tells a very simple story:
The top chart shows the market crash of 2000. As you can see from the red line, within two years, startup valuations fell from $12 million to $5 million — a drop of more than 50%.
And the bottom chart tells the same story for the crash of 2008 — but this time, startup valuations dropped 50% in just one year!
Bottom line: if the stock market continues to drop, especially the tech heavy Nasdaq, once again, startup valuations should fall right along with it.
Got it? Great. So now let me explain why this could mean more money for you.
By the Numbers
When you make a startup investment, you set a profit target.
Most venture capitalists and angels aim for a 10x profit on all their investments. That’s a 1,000% return.
Furthermore, a successful startup is more likely to get acquired than to go IPO.
The thing is, according to PricewaterhouseCoopers and Thomson Reuters, most technology acquisitions take place below $100 million.
What’s all this mean for you? Simple:
To give yourself the highest probability of making 10x your money, you should invest at valuations of $10 million or less!
More Chances to Makes 1,000%
Over the past few years, valuations for startups have gone through the roof.
According to data from Cendana Capital, in 2021, the average valuation for an early-stage startup reached more than $15 million.
That’s 50% higher than the valuation you should be targeting as an entry price!
But if the market continues to pull back, that could be great news for startup investors…
Again, if startup valuations drop by 50%, like they have during previous downturns, you’ll have many more chances to earn 1,000% on your money!
If you’d like to learn more basic lessons like this about startup investing, check out the free collection of Resources we created for all our readers »