Why investing in startups could be the key to success during an economic downturn
During market downturns, the best investment opportunities arise. This applies to both stocks and investing in technological startups. In times of crisis and high inflation, leaving money lying in accounts is not advisable. Those who start investing now will have greater profits in the future.
There is one fundamental difference between investing in stocks and investing in startups. "When investing in stocks, it is difficult to determine the bottom. Adjusting the investment strategy in line with the market and gradually making purchases is necessary. When investing in startups, the advantage is that it is not necessary to take as much account of market fluctuations. When potentially profitable projects arise, it is better to approach them when the market cools down," explains Petr Šíma, partner at DEPO Ventures.
Why? Last year, there was a large surplus of money on the markets and startup founders had many potential investors to choose from. Now, there is less available capital. Even the founders of the most promising startups are more willing to negotiate, are more modest and do not expect high valuations. This gives investors a better chance of finding a good project. "When startups have limited access to financing, only the really high-quality ones will be financed. In previous years, when there were many investors in the market - many of whom did not understand the essence of the matter - even bad projects were financed," adds Šíma.
Significant American investors say that tourist investors have now disappeared from the market. Those who heard that investing in startups is cool didn't understand it very well. "And that's good for the market," adds Šíma. When the cycle turns and the crisis passes, the economy will be in a boom and these good projects will seek new investors or sell for much more money. Like stocks, investing in startups at the peak doesn't make sense. It's expensive and at the same time it's likely that at the moment when a startup launches its next investment round or is for sale, a recession will occur. Long-term investment in startups is one of the most profitable asset classes, surpassing all other investments in securities, including riskier hedge funds.
A bet on future success
According to Šíma, the current slowdown represents a significant opportunity for emerging technology companies. "People are suddenly open to new solutions. They need to solve something currently troubling them. And someone who comes up with a cheaper or more efficient solution will likely succeed. When everything is going well, everything is established and nothing needs to be changed, startups are paradoxically a bit worse off because there aren't as many gaps in the market for them to fill," says Šíma.
Warren Buffett invests for the long term, looking for stocks of companies where he sees a long-term opportunity, betting on the company's value. And he's just looking for the right opportunity to buy, but he doesn't make decisions based on the current moods in the market. It's similar to startups. Investment in technology companies is a bet on the future success of a smart founder, his team and a quality project. Šíma even says that people are more important: "When you come across a good idea, but don't have much faith in the people associated with it, it's better to walk away." He advises future startup investors that they should not go into the first investments alone. Even though these are investments in early-stage companies, it is still a lot of money. In addition, investors usually don't have time to look for and go through projects. "That's why DEPO Ventures has a team of analysts who go through thousands of companies and select the most interesting ones with the potential for global success. We invested in twelve last year for interest in the nearly two thousand projects. That's about one percent," adds Šíma.
Opportunity for active and passive investors
DEPO Ventures opened its third fund this fall and started looking for investors. The first investments within the fund won't be long in coming, focusing on advanced technologies such as artificial intelligence or blockchain, financial technologies or technological marketplaces.
DEPO Ventures investors can actively participate in managing startups, which is attractive for many of them. But there is no obligation on their part. "Financial investors who see an interesting opportunity to increase their money can also invest with us," says Šíma. Every investor is different, but it usually goes in waves. "At first, they want to be active. Then they find out they don't see everything. But over time, there will be a startup in the field they understand and they will focus on it completely," describes Šíma.
The most common investors in DEPO Ventures funds are highly positioned managers, many of whom are trying it out for the first time. The involvement of these managers, who are experts in their field, is a huge benefit for startups themselves. "They help founders determine the direction, advise them on business, recommend their contacts, open doors for them. And on the other hand, they appreciate that they no longer have to worry about the investment process itself. They are happy that we do the due diligence for them that we prepare contracts," says Šíma.
Investing in the long term
According to Šíma, the current time does not bring any additional risks for startup investors. What always applies is important. It is important to build an investment portfolio. You can't choose one or two startups and hope they'll break through. You need to choose a lot of startups. The possibility that a startup will not succeed, that its value will drop to zero, is high. On the other hand, there is a high probability that one successful investment will outweigh twenty unsuccessful ones.
The investor must also consider that investments in technology are illiquid and cannot be easily sold. It's not a game for a few weeks or months, but rather for years. The usual investment horizon ranges from five to ten years.
It is only for qualified investors with millions to spare and want to invest in them. But it's not for billionaires, either. "We're not looking for those either. People with that kind of money can't deal with investments in the millions," says Šíma. "I like to say that investing in startups is for people who have money but still want to make the most of it. People with much more money are looking for ways to avoid losing it. They're more conservative. Exceptions, of course, exist," concludes Šíma.
Education is very important in this environment. That's why DEPO Ventures is organizing the fourth Engaged Investments conference, which will take place on October 24-25 at the Kaiserštejnský Palace. Over twenty speakers, three hundred investors, and their startups from Central and Eastern Europe will come together. The event is suitable for both experienced investors and those who are just considering investing in startups. Participants can look forward to inspiring panel discussions, workshops, round tables, startup presentations and networking. More information about the event is available on the engaged.investments website.