5 Important questions you should ask yourself before investing in startup
Portfolio management involves selecting and managing an investment policy that minimizes risk and maximizes return on investments. There are many complexities which is why many people turn toward expert financial advisors to help them navigate the tricky waters of investing and the financial marketplace. Read below to educate yourself on the basics of portfolio management and importance of a portfolio management strategy. After reading the article you should be able to set up your own investment strategy.
1. How much money should I invest?
Start by determining how much of your funds you want to invest can set aside for startups. Depending on how much you want to be involved as an investor, the following three options can be considered:
- f you want to become a passive investor, set aside a maximum of of your assets;
- If you have the time and desire to invest from time to time, you can invest in 10% of your assets;
- If you want to become an angel investor and devote yourself fully to startups, you can set aside up to 20% (and more at your discretion) of your total investment portfolio.
Why? Although investing in the early stages of technology companies is associated with unprecedented potential return compared to other asset classes (if we do not take into account speculative investments in cryptocurrencies), it is also necessary to take into account the high risk associated with investing in startups. In other words, we can also say that it is generally appropriate to invest only the amount of funds that you (reluctantly) can lose and it will not endanger your standard of living in any way.
Tip: It pays to bet on the fastest horses. Successful startups can even go through six investment rounds in their life cycle. In each investment round, new shares or stocks are issued and the share of the original shareholders is thus evenly diluted. Therefore, it pays to keep part of the allocation of investment funds to adjust this dilution and thus maintain the same share as when joining the company. VC funds keep from 30 to 50% of the total capital for such an allocation. For angel investors, the recommended allocation rate is around 20%. However, it always depends on the individual decision of the investor depending on the overall form of the investment strategy.
2. How many companies should I invest in?
With high risk investments the importance of diversification is growing. Never bet everything on one card, even if the startup excites you the most. Some surveys indicate that when investing in at least 25 companies, the probability of reaching more than twice the invested capital is more than 60%. We recommend targeting at least 20 investments over five years, based on four investments per year. This will ensure a statistically balanced evenly distributed portfolio. You won't be sorry if several companies fail, and at the same time the chances that you've hit at least one that will succeed will increase.
3. Which companies should I invest in?
As part of diversification, you should invest not only in startups and technologies that you like and understand, but also in those that are current trends or that have the potential to shape the future.
For some investors, the goal may not only be financial gain, and they may make decisions based on other criteria, such as investing in sustainable development goals (SDGs), i.e., those that have a social or environmental impact.
A quality startup should come up with a unique solution to a specific problem, with a well-targeted and at the same time large target group. The business model should be scalable, have minimal and well-named competition and also a strong team with a clear vision.
Last but not least, choose based on your own instinct and sympathy for the founders. It is important that you catch the eye of the founders, because you will communicate with each other for the next few years and you must trust each other.
4. How much time should I devote to individual companies?
A key question that not all investors ask themselves. Do I want to be just a financial investor and startups are a way of portfolio diversification for me, or do I want to be an active (angel) investor who, with his experience, knowledge or business contacts, will help his portfolio on a regular basis?
Assuming you have a portfolio of 20 companies and you are in the role of a purely financial investor, the amount of time spent managing it is relatively low (maximum units of hours per week). However, if you are an active angel investor, it can be a full-fledged work commitment in the range of 30 to 40 hours per week, especially in the first two years after the investment.
5. How to set my return expectations regarding time horizont and profitability?
Professional VC investors usually expect an investment horizon of at least five years. The average time from the establishment of the company to the IPO (the first public offering of shares) used to be between 7 and 9 years. Today, this time is moving to 9 years or more. If the funded companies are successful, the first opportunities to sell part or all of the stake come after the first three to four years after the investment. This is usually the case when large foreign VC funds enter, whose interest is the consolidation of shares and thus control in the company. For the peace of mind of every investor, it is reasonable to count on limited liquidity of the investment within a horizon of 10 years.
In terms of profitability, it is possible for startups to achieve an order of magnitude higher appreciation compared to other asset classes. Jason Calacanis, one of Angel's best-known investors and one of Uber's first investors, has valued his investment more than 14,000 times. Of course, these cases are rather rare. The realistic target of average portfolio appreciation may be three times the total invested capital. However, it is important to distinguish between the expected return on individual investment and the average expected return on portfolio. You should also take this indicator into account when deciding on individual investment opportunities and invest only in those that have the potential for appreciation at least at the level of the total amount of investment funds that you have reserved for investments in startups. In other words, one investment (startup) should always have at least the potential to return all investment capital (portfolio).