Investing in startups is risky! In fact, it is considered one of the riskiest asset classes. Odds are against you if you are betting on early-stage startups. However, venture capital has come to be a ‘must-have’ within one’s investment portfolio. In this feature, I will share what approach you can take towards startup investing, asset allocation for startups, building your portfolio based on your strengths, and more.
Let’s Start with WHY – Why invest in startups?
This is an easy one – startup investments – if you get them right will give you incredible returns. What do I mean by incredible returns? Well, the expected gross IRR for investing in early-stage startups is between 20% – 30%. As an extreme example, Peter Thiel’s initial investment in Facebook increased in value by over 2300X prior to IPO.
Another reason why many ‘angels’ invest in startups is to contribute to the cause or the journey of building something exceptional. Maybe a business that the angel herself/himself can’t build now but wants to contribute through capital, network, and guidance (in exchange for equity).
Some clarifications here…
What I mean by ‘early-stage startups’
Early-stage startups are recently formed companies that have revenues less than $500k, and looking to grow rapidly (15+% month over month). However, many venture capital firms invest in late-stage companies with valuations over $100mn. Example – Softbank investing in Unacademy at $1.5Bn valuation or the famous WeWork example.
Timeline & Liquidity
Startup investments are highly illiquid, unlike fixed deposits or stock market investments where you can sell and get the money in your bank within a few days. If you are investing in startups, expect it to be for the long term (3-10 years), with no/little liquidity.
Will you definitely get your money back?
No. Invest in startups only if you can afford to lose the money and that won’t materially affect your financial sustainability. One of the most respected stock market investors recently told me – “Startup investment is a get-rich-quick scheme, and I am happy if I can get 12% annual returns on my investments”.
How much should you invest in startups?
Roughly 5% of your portfolio could be invested in startups. However, ‘it depends’ on many factors such as your risk appetite, current asset allocation, and most importantly your wealth growth plan.
OK! Say you’ve decided to invest in startups (with your eyes open), now what?
Decide how much you plan to invest in startups each year because it’s a long term game. You are likely to spend the first year learning the game to refine it over the next few years.
Based on my calculations, if one invests in roughly 10-11 startups per year for three years then it’s possible to build a decent portfolio of startups that gets you returns and builds access to future deals.