Investing in startups is trending, but the million dollar question is how to generate outsized returns?
How do you actually make real money?
If you had invested just $10,000 in Amazon, Dell, Apple, or Microsoft, when they went IPO, you’d be a million dollars richer just from that investment according to the IPO Playbook. Apple kicked that 100x ‘Franklin Multiple’ to the curb with a 4,581.7% rise in stock value between 2002 and 2012 alone.
For some of you reading this, $1million may just be chump change. But imagine if you had invested long before the IPO? How would that make you feel right now? What would that do for you?
Even Mark Zuckerberg’s net worth has been trumped by Uber founder Travis Kalanick, at $6B as of 2015. But as a startup investor you don’t have to be the founder, and do all the work to experience viral investment returns.
As a disclaimer, while there are best practices to follow when venture investing, before making money, it is likely that you will lose a bunch. Investing in early-stage startups is truly an art and like leading Venture Capital firm First Round puts it, “there’s no such thing as a formula for success.” But instead of going at it on your own, it does help to leverage investing platforms like 1000 Angels (a company I co-founded) that offers highly curated, direct investment opportunities that are deeply vetted. It takes a lot of the heavy lifting out of venture investing.
However, for some, startup investing has proven to work mind-blowingly well, and many individuals are finding this an absolutely essential financial move for generating the returns and results they crave. So what are the specific advantages of investing in early stage startups? How can you invest in startups too? How do you actually make money doing it, while minimizing risk, and elevating reward potential? How do you pick awesome startup investments?
Four Reasons People Invest in Startups:
- Potentially generating uncorrelated outsized returns and provides portfolio diversification
- Looking super smart when you’re winning startup picks become hot trending topics
- The desire to generate enhanced investment returns for their investment portfolio for retirement and beyond
- Craving to be involved in driving positive change, bringing new solutions to life
The Smart Money Goes to Startup Investing
Investing in startups is what many intelligent, successful, wealthy individuals do when they have to put their own money to work. That should speak for itself.
When people need money for their business, they turn to wealthy investors as seen on ABC’s Shark Tank. Think Mark Cuban, Daymond John, and Barbara Corcoran. Then there are Silicon Valley legends like PayPal co-founder Peter Theil.
Thanks to the JOBS Act, investing in startups is no longer only the reserve of the uber-wealthy. It is now effectively open to all accredited investors. Those that have thrown themselves into this wealth vehicle have been finding very exciting results. Even New York Times Bestselling author Tim Ferriss, says “so far my startup bets are 10x+ more successful than my publishing career.”
The bottom line is that if you take a moment to look at your finances, investment projections, retirement needs, and both financial and non-financial goals; investing a portion of your investment portfolio in rapidly growing startups may help to achieve this goal and help close the gap, but it’s in no way a guaranty and it’s highly risky.
How Can I Invest in Startups?
Angel investor Paul Graham says after selling his startup he planned to do some startup investing. Although he is now one of the most recognizable voices in this arena it took him 7 years to get going; saying “I put it off because it seemed mysterious and complicated. It turns out to be easier than I expected, and also more interesting. The part I thought was hard, the mechanics of investing, really isn’t. You give a startup money and they give you stock.”
That was years ago. Now there are many more, and easier ways to invest in startups:
- Investing via venture investing platforms for direct investments
- Investing in startups through your IRA or self-directed 401k (PENSCO and Millennium Trust help with this service)
- Via personal connections and relationships with entrepreneurs and founders
- Attending pitch events
- Join a syndicate on AngelList if you prefer to follow other investors
Generally you simply make the investment in person or via an online platform, and receive preferred stock, or convertible notes or SAFE notes which convert your interest to stock at the next major milestone.
How to Cash Out from Investing in Startups
Gains from investing in startups may be realized in several ways:
- The startup is acquired by another company (think Instagram and Facebook)
- The startup goes IPO
- The company begins paying dividends
- Investors sell their shares to other investors
Best Practices & Startup Investment Strategies
The truth is that there may only be one ‘golden rule’ to startup investing. That is to expect risk, and not to invest more than you can afford to lose in any single investment.
Startup Investing Smarts:
Invest Smart, Efficiently & Profitably By:
✓ Investing in pre-vetted startups
✓ Take a portfolio approach and invest in a number of deals
✓ Reserve a portion of capital for follow-on rounds
✓ Invest in what you understand
✓ Invest in startups you may be able to add value
How You Invest is Important
How you scout and invest in startups is an important part of success. You don’t want to spend years crisscrossing the country in search of investment opportunities without making any actual investments. Wherever possible you want to optimize the process and costs so that you make the process efficient. Platforms like 1000Angels enables investors to attend exclusive events around the country to connect with startups for an annual membership fee, rather than giving up a percentage of the upside like you would get in traditional venture funds or syndicates. This platform may increase exposure to startup fundraising rounds and offer efficiency through curated investment opportunities.
Will you deploy Ron Conway’s ‘spray-and-pray’ strategy, or Peter Theil’s ‘all-in’ game plan?
One of the most common pieces of advice thrown around the investment world and internet today is to intensely diversify. That’s understandable given the volatile nature of startups, and the rarity of Facebook like success stories out of the 600,000 plus new small businesses incorporated in the USA each year. Yet, some of the most successful startup investors like PayPal co-founder Peter Theil take serious issue with this. Peter points out that in most cases investors and venture capital firms will find that one winning investment will far outweigh the performance of all of their other investments. Theil warns that this ‘Power Law’ also means that if you are constantly making $250,000 blind bets, you are going to need some pretty big wins just to stay even. He says ‘spray-and-pray’ is likely to produce a whole portfolio of flops. Contrast that with focusing on more highly curated startup opportunities with potential for success. In the book Zero to One we’re reminded how Andreessen Horowitz invested $250k in Instagram. Two years later it was bought for $1B by Facebook, returning a 312x return, or $78M on that initial $250k. If you had been one of the early investors in Facebook, or Uber, none of your other investments would likely even register on the scale in comparison.
Do diversify, but choose your investments wisely. Blindly spraying and praying across every pitch any entrepreneur presents is virtually guaranteed to result in a myriad of losses, even if one win makes up for those, and more. Instead consider going heavy into a select handful that you really believe in. Diversify across different industries such as healthcare startups, real estate startups, and something else just to be buffered from potential industry fluctuations. But focus on funding individual companies with promise. By putting your capital and energy into fewer select firms you’ll make far more positive impact on the success of that venture.
Date: 17 Nov 2015
Author: Tanya Prive