Investing into startup companies is becoming more and more of a interest for a growing number of the wealthy.
The reasons for this development are multifold. There’s the media hype around startups who made their investors and founders rich and hip; there’s also a true entrepreneurial calling. This means that even if they were not concept creators, they would like to be an integral part of the startup by supplying essential funds to help it succeed.
Investing into startups also reflects a true desire to boost economic growth, change social or environmental problems, and to bring innovation to life.
In short, it is motivated either by the pure potential of monetary gain (and sometimes the desire for fame) or by the dream that the technology/product/service is something new/unique/groundbreaking/problem, solving while being economically viable, or by a combination of both.
When you venture towards these startups, you should follow some basic rules.
1. Never invest in something you don’t understand. If you have expertise in a field, start there. If a field is interesting you, start there.
2. Don’t start with investing money. Invest time instead. Attend startup conferences and meet founders and other investors. Listen and ask questions, focusing on the failures rather than the successes - they are the sources from which you can learn. Ask other investors about legal counseling, about accountants, and other advisors they work with. You do not want to pay your current lawyer/advisors to learn about the trade.
3. Learn the startup language. In the beginning, you may experience l a tsunami of legal language, for example,‘premoney and postmoney valuation’, ‘convertible debt’ (or loan), ‘dilution’, ‘tag’, and ‘drag-alongs’, will go over your head. You need to know and understand these terms in order not to lose equity, profits, and control in your investment. Learning is quite easy, and you will find masses of youtube videos about investing in startups which might help you.
4. Do your own due diligence, but don’t overdo it. If it’s possible, ask potential customers key questions such as what is the product/service, how expensive is it, who cares about it, who decides, who pays for the product / service and how much must be part of your due diligence list. If, for instance, the answer to the key ‘who’ questions are three different groups, then the business case is very challenging and you might not want to start with something like that.
5. Know the risk, but don’t get paranoid. Stay relaxed by only investing money you can afford to lose. There is a 2013 quote from Forbes Magazine that eight out of 10 startups fail within the first 18 months. However, the US Bureau for Labor Statistics has brought forward more optimistic data: 50 percent of all new businesses make it to their fifth year and 33 percent make it to their 10th.
6. Never invest with people (other investors) or in people (teams) you don’t like or trust. In the life of each startup, there will be rough times. If a sound and healthy personal basis does not exist, the human factor will kill the business for sure.
7. Don’t be afraid to walk away from a deal and don’t let yourself be pressured to sign something that doesn’t feel right. Your gut feeling is one of your best due diligence tools. If something sounds too good to be true, it is very likely too good to be true.
8. Don’t start with big tickets. Invest smaller sums and use the first five to six investments to learn the trade and build up a network.
9. Build up your own network of investors. Investing is a team sport, so you would rather find your own team members. You can form a special purpose vehicle with other investors where you pool all your money and invest, or you can invest alongside each other. There are also investor circles who share leads, expertise, and investments with each other.
10. Start investing only with investors who invest their own money, not investors who invest other people’s money. Venture capital funds can afford to lose their invested money for example. It is actually in their business model that two out of 10 investments ‘go big’ and make the fund profitable, whereas eight are expected to fail. If you invest alongside with them, your potential failure rate will be at 80 percent.
11. Be patient. Sometimes it is good to wait for the next investment round.
12. Offer more than just money. In addition to cash, startups need expertise. By working with/advising them on a pro bono basis, you get to know them more deeply. The service/product will grow better, which will might drive you to invest on a later stage.