It is a common misconception that investing in startups is for the uber-wealthy, venture capital and angel investing insiders; being exclusive and risky — an alternative asset class where losing is part of the strategy.
Venture capitalists leaders highlight how often you lose before you win. Thought leader Fred Wilson of Union Square Ventures says,
“Investing in startups is risky. If you make just one investment, you are likely going to lose everything. If you make two, you are still likely to lose money. If you make five, you might get all your money back across all five investments. If you make ten, you might start making money on the aggregate set of investments.”
How Much to Invest
That being said, no one will advise you to put a large percentage of your savings into early stage companies. However, if you allocate 5% of your overall portfolio into startup investments you can increase returns and reduce risk. According to a SharesPost whitepaper, if you allocate 5% of your investments to private growth companies, you can increase the returns of a traditional portfolio by 12%.
Successful venture capital firms generate approximately 80 percent of their returns from less than 20 percent of their investments. So I know my odds are 90 percent of my cash returns will come from 10 percent of the winners.
How Many to Invest
The next question is: how many companies should you invest in to create a diversified startup portfolio? Experts from the Kaufman Foundation Returns to Angel Investors report and Dave S. Rose in his book Angel Investing: The Gust Guide to Making Money and Having Fun Investing in Startups suggest investing in 12 to 15 companies to generate a 2.6 times return on your investment in three to five years.
According to the Siding with the Angels report by Nesta, of the ten startups they recommend as the minimum number to invest in: 1 or 2 businesses soar, 2 or 3 will do okay, and the rest will fail. Again, if done properly, the returns can far outweigh the losses, allowing investors to generate around 25% ROI per year.
What Criteria to Invest
The final question is: what is the basic criteria to create a diversified startup investment portfolio? Fortunately many online investing platforms, including OurCrowd, has startup investing funds where you can invest $50K into multiple companies that experts choose and manage.
But if you have the time and the interest to choose the companies, you can do it with these three basic rules. Each of the companies should range in [1] the stage of the life of the company (based on time and progress), [2] the industry or sector (advertising, financial, health and wellness, cyber security, e-commerce, mobile, etc.), and [3] geography (US, Israel, India, etc.).
There are plenty of materials written about specific criteria on how to evaluate and choose startups. But a good rule of thumb is you should invest in ideas you understand and select every investment as though it’s your only one. If you lower the bar you will only build a bad portfolio.
To start creating your own startup investment portfolio I encourage you to visit the online equity crowdfunding platforms that allow you to invest in vetted startups alongside other angel investors and venture capitalists.
First-time investors need to remember that backing private startups is risky and is very different than investing in public stocks. Risks aside, there are strong reasons for smart investors to diversify their portfolio and allocate a small percentage to startups.
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Written by Audrey Jacobs, VP at OurCrowd
Prior to OurCrowd, Audrey spent 20 years building brands for technology companies with leading global public relations firms like Porter Novelli and launched the US Israel Startup Nations Series to create partnerships and educate about the opportunities of investing in Israeli innovation. To contact Audrey Jacobs, follow her on Linkedin / Twitter
