Personal notes from a course I recently took through Stanford’s Continuing Education program on investing in early stage startups. Please comment or share your thoughts below!
Success is (unfortunately) today measured by the level of return i.e., your ROI; everything else is secondary
- Investing success = a return on investment i.e., making money!
- If you are interested in having impact, consider the fact that the more money you make, the more you have to give to change the world
- When you try to attain both return and impact simultaneously, you may get run into a conflict of interest
Before investing, carefully consider the types and level of risk you are willing to take
Risks may be categorized into the following:
- Founder/Team Risk
- Is the founder/are the founders coachable?
- How do they take criticism? Do they get defensive? Test to ensure they are open and willing to learn
- Make sure the founders are aligned by probing on the founder relationship (e.g., does one talk over the other, do you sense tension, what is the depth of their relationship, have they worked together successfully in the past)
- Ask to see the hiring plan, and try to poke hole in it (e.g., not hiring sales for a year, who is going to take on that role?)
- Is the founder/are the founders coachable?
- Technology Risk
- As an investor, your job is to identify if there is a risk there; when an entrepreneur pitches, do the demo at the end if there is ample time, focus instead on getting to know the founder and their business
- Do not fall in love with the technology; this is an easy miss that can lead to a faulty business/execution because you were mesmerized and ultimately distracted by the tech
- Market Risk
- Consider what is going to happen to the business long-term; the risk is that the business becomes a “lifestyle business” i.e., great for the entrepreneur (provides a comfortable lifestyle, cash cow) but for the investor who puts in the initial capital, you may never see your money again because the entrepreneur has zero incentives to return to investors (they hit a plateau)
- Structure some form of divided or management buyout; you will get your dollars back eventually, but the entrepreneur will provide a portion of earnings over X years if there is no exit event
- Determine whether this is a risk you are willing to take in terms of working capital
- Execution Risk
- Consider the eventual buyers of this business, what the company may be valued at, and how many players could afford to buy at that price
- If you invest late, you’ll need a BIG exit, while early investors shoulder greater execution risk
- Financial Risk
- Pick your co-investors (if you choose to co-invest alongside established VC firms) wisely; make sure you can rely on them as if one pulls out it could jeopardize all
- Find team players to co-invest with
Decide whether you want to be an active or passive investor and allocate your time accordingly
Are you an active or passive investor? Think through the following:
- At a high level, active investors get super involved whereas passive investors just write checks
- If you have a diversified portfolio and don’t have a ton of time, stick to passive investing; if you have a smaller portfolio, can be more active
- One common mistake for active investors is to think “I’ve been a great ___________ [product leader, entrepreneur etc.] so I will be a great investor!” – this is not true! Being a great physician will not make you a good writer, and vice versa