Even the most experienced private equity investors see startups as a very particular class of asset. They are completely right – no doubt about that. But even if investing in startups is a very particular job because of the great risk involved and the non-liquid aspect of the shares, there are still a few simple rules that are as true for startups as they are for public stocks or any other investment.
Stick to what you know: A robot advisor or algorithmic trader could achieve great results in Bonds, FX, etc. But in venture capital or private equity: forget it. Startups are typically disruptive digital tech companies, but investing more than a few £1000s in startups is neither tech, nor digital, nor automatable. It is more of a craft industry that some investment firms have managed to industrialise (Accel, Balderton and others), but no one has managed to dehumanise. Even Google’s attempts to use automated, algorithmic private equity investments have had some pretty bad results.
Know the founders, sector and market and then consider investing.
Diversify your investments: As any good asset manager or private banker will tell you, sometimes your investment strategy is more important than whether you have a good or bad investment. One good strategy is to diversify. It works for a global distribution of assets such as cash, real estate, bonds, shares and startups. And it also works within a single category. What could be a diversification strategy for investing in startups?
First, if you have £1m you want to invest, investing £1m in a single company you believe might be rewarding is extremely risky. See your startup investment portfolio as any other portfolio. And consider that on ten investments:
- 5 to 7 will bring no return at all (i.e. the startup died)
- 3 to 4 will bring no or few return (i.e. the startup turn out to be a modest SME, slightly profitable, delivering no dividends and being of no interest for potential buyers. Remember that nothing is more illiquid than the shares of a modest SME…)
- (Maybe) one will bring so much return that it will cover all the losses of the nine others.
Diversify your sectors unless you are an industry specialist. Even if you strongly believe that Data Visualisation or Blockchain will be the next big thing, do not invest all in one or two sectors. This is not only because you could be wrong, but also because there is too much variability on the time to market and the market maturity of these new areas in tech. An interesting strategy could be to invest in some close-to-market startups such as B2B software and B2C payments and more long shot sectors such as C2C payment, IA, and so on.
Investing in startups is very exciting. And well-informed diversification will help to spread the risk across time and sectors.
[author title=”Early Metrics” image=”http://i66.tinypic.com/dz7yhe.png”] Antoine Baschiera is the CEO and Co-Founder of Early Metrics.[/author]