So you want to invest in startups? Josh Liggett, Investor Relations expert at OurCrowd, brings you the top 9 rules that VC gurus follow.
When thinking about building a startup investment portfolio, the usual rules simply don’t apply. After years in this unique niche, I can tell you that playing it safe doesn’t cut it. A startup is the opposite of a sure thing, but when it succeeds, with the right idea and proper care, the rewards are huge. Here are some of the top tips on getting in on the ground floor.
- Diversification is key
Throw a rock at a startup investment website and you’re bound to hit 4 articles on diversification. For one, famous venture capitalist Fred Wilson has written extensively about the importance of diversification in a VC portfolio. The more spread out, the better the odds to strike it lucky. To paraphrase Wilson, you need to invest in at least 10 different startups in order to start seeing any type of return. If you’re not willing to make that type of commitment, startup investing might not be for you.
- Feel the power…law
Successful VC’s all have one thing in common: They embrace the power law. Essentially, the vast majority of startups you invest in will fail, but a very small group may just be a home run. Embracing failure as a routine part of the startup lifecycle means the winners are few and mighty. In industry speak: swing for the fences on every investment in order to make up for failures and generate profits.
- Team Team Team…ideas vs execution
Coming up with a great product is only half the battle; execution is essential to a startup’s success, and a great team is your best bet to take you to the promised land. Many VCs stress the importance of having a rock-star/all-star/mon-star team at a startup before taking the investment plunge, and so should you. Having the right people in place is make or break for even the best ideas, so look beyond flashy presentations and bedazzling technology to the people behind it.
- Know your market
What’s the size of the market you’re investing in? What is the cap for how big this company can be? If you’re investing in a company at a $20 million valuation, but the market size is $21 million, there isn’t much room for growth (read: profits in your pocket.) Harvard Business Review, Forbes, and other publications have all featured articles on knowing your market size before an investment. Knowing the nature of the beast makes predicting payout size that much more realistic. Invest the time in independent market research.
- Double down on winners
Startup investing is like poker- you gotta know when to hold ‘em and know when to fold em. Saving money “to bet” via follow-on rounds for the winners, and knowing when to “check” on the losers is essential to making the most out of your allocated funds. Just because you entered the round once doesn’t mean you need to do it again. Reevaluating the progress and potential at the follow-on stage is complicated, and emotional. Business Insider labeled deciding whether or not to invest in a follow-on round as the biggest challenge in VC. Follow your instincts, and don’t be afraid to let one go.
- Don’t just invest, nurture
Ask any entrepreneur, and they’ll tell you money is the easiest thing to come by. What really helps startups grow are the relationships investors bring to the table. Armed with a great idea and a fabulous team, young companies still need to make an impact on their industries, and nothing does that more than a productive introduction. Building quality teams for your investment companies make their success more attainable. So don’t just invest capital; invest the time to look at your own rolodex and see who you know who can help the startup grow. Occasionally, that person may just be you. So get your hands dirty and dedicate some time to mentor/advise if you have the right experience, it will be appreciated, and will give your company that much more oomph.
- Be a contrarian thinker
Don’t be afraid to tell people they’re wrong. When looking to the future, you may need to think outside the box… Just because everyone disagrees doesn’t mean you aren’t right. History wasn’t made by people who thought like everyone else. Investing in the status quo doesn’t reap high rewards, so embrace your inner Peter Theil and fly in the face of conventional thinking.
- Don’t look to improve, look to revolutionize
To paraphrase Danyrus Targaryan: Don’t reinvent the wheel, break the wheel. The best startups were defined by dreaming up an entirely new space. If you own the market, you own the profits. Creating an improvement to a product can be great, but companies that are disruptive and revolutionary have a better chance of being a home run investment. It’s what innovation is all about.
Finally: Patience. Patience is key when it comes to startup investing, and the road to an exit is usually a roller coaster ride. Having the endurance to stick with an investment you believe in and not see anything for a few years is the foundation of the VC industry. While it sounds fast-paced, startup investing is a long-term endeavor. Keep your goals clear, and be prepared for the long haul.
Sound like a good fit? Find out about the first steps you can take towards startup investing here.