If you think getting rich is about a "diversified portfolio" when it comes to investing, maybe investing in startups isn't for you. While diversification will keep your money "safer" — if there is such a thing — funding startups and making acquisitions is about focus and making big bets in businesses that are often wild and crazy. Here are some tips for those who like to put their arms up when on the roller coaster.
INVEST IN BUSINESSES YOU CAN INFLUENCE
Failure rates for startups and VC firms are commonly very high, with a small minority of investments yielding all profits. Between 70% and 90% fail within 10 years.
Put yourself into investments where you can help make things happen. This is called "smart money," which means you can provide consulting or advice to the project rather than just injecting money. Play to your strengths, and consider how you can steer or help a business become more successful instead of being a bystander hoping for success.
A decade ago, in my younger years, I invested in a friend's dream and bought a bar and restaurant. It ended in spectacular failure. I had partnered with the wrong operator and was not in a position to influence the business's success. Aside from being an avid foodie and wine connoisseur, I knew nothing about the restaurant business, and still don't. I learned to stick to companies I knew more about or things I could influence.
Make it clear what types of help you can provide. Help with marketing, consulting and introductions is most common, and that is what I often offer to startup founders. For example, my marketing firm provides email marketing services to an ecommerce company I am invested in. The founder calls me when he wants my thoughts on big decisions or when he needs help. Often, they ask about problems I've solved before for my own companies. As a business broker, when an acquisition opportunity came their way, I performed due diligence, vetting and financing — and buying that website doubled that company’s revenues and profit margin. These are concrete ways of influencing what you've invested in to maximize success. Use your talents to benefit them, which helps you.
CLOSE THE DEAL AND GET OUT OF THE WAY
Investors are betting on people to execute a vision that will ultimately be profitable. Startups need money, and they usually need it quickly. It is vitally important that you evaluate businesses rapidly. Only agree to invest with funds you have readily available. An investor should be able to sign an agreement and send funds immediately. When negotiating, it's okay to be greedy, but don't be annoying. Everyone thinks they're clever when asking for advisory shares or board seats. Advisory shares are frequently used to get more shares of a company and a "lower valuation" without hurting other investors. Board composition is a critical component and is built carefully. Sure, it's nice to have more "power," but you want a company that runs and earns you money without you.
My advice? If you want it, earn it. Startups always need more money, and there are always more chances to double down on your investment. Founders want to build their team and company culture, and you might not fit in. That means it's not your place to try to force yourself into the company and its corporate responsibilities, or let your ego get in the way of their operations. Suppose, after your initial investment, you've grown your relationship with the founders and provided good value to the startup. In that case, both you and the company will be better positioned to decide if giving you advisory shares or a board seat is appropriate. Until then, you should cause as little friction as possible and stay out of their way.
SUCCESS IS USUALLY A SERIES OF FAILURES AND ONE SUCCESS
If you invest in startups, the risks and rewards are ridiculously high. You cannot put all your eggs into one basket and you will most likely suffer tremendous losses on your way to success. Failure rates for startups and VC firms are commonly very high, with a small minority of investments yielding all profits. Between 70% and 90% fail within 10 years. That means you have to invest in at least seven to 10 companies — and vet them well — in the hope that one investment will provide a tenfold return. Can you invest in one big thing and be successful? Sure. Is that likely? Nope.
This is not to be confused with diversification across multiple industries or business sectors as a safeguard for a balanced portfolio. Choosing a sector to focus on in startups is vital because of the level of confidence needed to invest in them. What is essential is making numerous bets in your field of specialty because the failures will be catastrophic, and your profits will depend on the survivors.
Years ago, I invested in a company post-IPO that my broker at a prominent wealth management firm didn't know much about. The stock was wildly volatile, and the firm I was with was not providing any guidance on the stock. Whenever it dropped, I bought more because I believed the company would ultimately succeed in its wild bet on the future, despite at times operating on the brink of failure at the hand of an unpredictable CEO. Tesla later became the best performing stock of 2020, providing a 7.4 times return that year. It made up for my other tech investments that turned out to be losers.
Investing in non-public startup companies is mostly the same. Investors always have some that stink and some that succeed, and sometimes it is surprising which ones make it and which ones don't. You make money with big risks, big rewards and helping as much as possible along the way.
Juicy Jay is the CEO and founder of the JuicyAds advertising network, as well as the founder of Broker.xxx, which helps people buy and sell adult websites and businesses. He also provides executive consulting, business strategy and marketing services at Consulting.xxx.
