I’ve been dabbling in startup investing for a few years now. Nothing extraordinary, and I’ve definitely not made it a career, but I have developed a guide of sorts that I follow when making the final decision of whether or not to invest.
This is written from the viewpoint of a single angel investor. Here it is:
- Risk: Understand the high risk in angel investing. Mentally, assume you’ll write off all investments as soon as you make them. Invest only what you can afford to lose.
- Avoid life-support investing: If a company comes for funding, where the founder says/implies something to the extent of: “fund us or we’re going out of business” – usually gravitate to not investing. Life support investing is a bad idea (not to mention stressful!).
Lean towards companies that will survive regardless of whether or not you invest in them.
- Three companies come in for funding:
A – Entrepreneur has the best idea ever! They need funds to build the product.
B – Entrepreneur has the best product ever! They need funds to market.
C – Entrepreneur has a product which shows great traction. They need funds to scale.
Everything else equal, investing in C has the most promise.
- Follow-up investor: For the new investor, prefer being a follow up investor rather than leading rounds.
- Investment hierarchy: First invest in companies with great traction. If that does not exist in the options, then invest in those with great people, followed by those with a great product.
- Bet on people rather than product: Early stages, funding is a bet on people rather than product. Products can change more easily than people.
- Never invest in something you don’t understand: Doesn’t matter what it is, who is involved, who has invested or how well the market is going.
- Entrepreneurial grit matters: Invest in entrepreneurs who show they’ll simply never give up on the company – no matter what. Perseverance is crucial. When things get hard (and in startups they will!), you want someone who has the grit to stick through it to figure a way out.
- Scaling: Always think about how the company can scale. If scaling is expensive or hard, lean towards not investing.
- Avoid niches: Niche markets are starting points – but that’s it. The ultimate market cannot remain in a niche space. Successful companies need to scale.
- Viable business or science project?: Is the company capable of being a business or will it remain a technology/project? Not all technologies can become businesses.
- The Fence: If you’re on the fence about a company for a long time – defer the investment.
- Entrepreneur’s knowledge: The entrepreneur needs to know more about the space than you. If you seem to know more about his own space – that’s a red flag.
- First versions will suck: Products require several iterations of trials and failure to become great. The key is if the entrepreneur/team is unfazed by failure to keep at it despite the obstacles.
- What if Google/FB does it?: Assume the incumbent is always going to copy the entrepreneur if he does well. What is his strategy?
- Does the product create delight?: Do you feel delighted when you use the entrepreneur’s product or service? If not, at least do the customers absolutely love the product? Defer the investment until that is true.
- Simple enough for your mother: Can your mother use the entrepreneur’s product or service? Simplicity is key for widespread adoption.
- Failure is a learning process: Past failures > No failures.
- Return time period: Expect returns no less than 5-7 years.
- Differentiate between the decision and outcome: Decisions must be taken using all information available to you at that time. You can’t predict the future and hindsight is always 20/20. A bad outcome does not necessarily mean a bad decision and vice versa. Don’t beat yourself up too much over a bad outcome, and then again don’t let a good outcome go to your head.
Good luck! And as always, if you do discover the next Google or Facebook, do let me know! 😉
With that said, here is the obligatory legal disclaimer that goes with any investment advice – Please invest at your own risk!