A quick guide to investing in startups

Investing in startups is trending, but the million-dollar issue is to generate outsized returns and make real money with minimal risk. Entrepreneur Alejandro Cremades shows us how

If you had invested just US$10,000 in Amazon, Dell, Apple or Microsoft when the companies offered an 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 per cent rise in stock value between 2002 and 2012 alone.

For some of you reading this, US$1 million 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‘s, at US$6 billion 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 VC firm First Round puts it, “There’s no such thing as a formula for success.”

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 minimising risk, and elevating reward potential? How do you pick awesome startup investments?

Four main reasons people invest in startups:

• Potentially generating uncorrelated outsized returns and portfolio diversification

• Looking super smart when their 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

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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 Thiel.

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.”

How can I invest in startups?

Angel investor Paul Graham says after selling his own startup, he planned to do some startup investing. Although he is now one of the most recognisable voices in this arena, it took him seven years to get going.

He says, “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 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, 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 realised in several ways:

• The startup is acquired by another company (think Instagram and Facebook)

• The startup offers an IPO

• The company begins paying dividends

• Investors sell their shares to other investors

Best practices and startup investment strategies

Invest smart, efficiently and 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 where 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 optimise the process and costs so that you make the process efficient.

Platforms like 1000Angels enable 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 deal flow and offer efficiency through curated investment opportunities.

Also Read: How to thrive in Vietnam and Thailand’s emerging startup world

Intelligent diversification

Will you deploy Ron Conway’s ‘spray-and-pray’ strategy, or Peter Thiel’s ‘all-in’ game plan?

One of the most common pieces of advice thrown around the investment world and the 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 US each year.

Yet, some of the most successful startup investors like Peter Thiel take serious issue with this. Thiel 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.

Contrast that with focussing on more highly-curated startup opportunities with potential for success. In his book Zero to One, we’re reminded how Andreessen Horowitz invested US$250,000 in Instagram. Two years later, it was bought for US$1 billion by Facebook, returning a 312x return, or US$78 million on that initial US$250,000. 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 a far more positive impact on the success of that venture.

The views expressed here are of the author’s, and e27 may not necessarily subscribe to them. e27 invites members from Asia’s tech industry and startup community to share their honest opinions and expert knowledge with our readers. If you are interested in sharing your point of view, please send us an email at writers[at]e27[dot]co

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