Adopt a Startup Investing Mindset
|By Chris Graebe|
My team and I are knee-deep in due diligence mode right now.
I’m literally on calls, texting or in some sort of online meeting most of the day. As I sit and write in the early morning hours before the chaos of the day hits me at 120 mph, I take a moment to reflect on the mindset it takes to be an early stage investor.
With that in mind, let’s dive into the three factors that I think play a critical role in having the correct mindset when it comes to investing in startups!
Let’s get started …
Factor No. 1: Understanding Your Relationship to Risk
& Always Having a Plan
According to businesswoman Mellody Hobson, "The biggest risk of all is not taking one."
This quote really resonates with me because you’ve probably heard me say this hundreds of times: The world of early stage investing is risky.
In essence, as investors, we are looking for and betting on ideas that could flop, founders who could go rogue, sectors that could be turned upside down in the swish of a legislative pen stroke. There are so many factors to consider when it comes to taking a chance on an early startup.
Now, if we just looked at all the possible pitfalls and decided to sit on the sidelines, we’d fall into the category Ms. Hobson is talking about. We would be doing nothing at all.
Another quote I love is by author Erwin McManus who states, “To play it safe is to lose the game.” In life, any big success I’ve experienced was always preceded by a large leap of courage and a significant amount of the unknown.
In short, it usually carries an enormous amount of risk.
So, if everyone assumes startups are super risky and will most likely fail from the get-go, no one would invest in them. And as a result, all this amazing innovation and technology we have today, thanks to the now-giant companies that used to be tiny startups, wouldn’t be here. All those companies would not exist,either.
The point is, we’re supposed to take a reasonable amount of risk to see rewards.
So, how do you and I walk this knife’s edge in our investing strategy while keeping a level head with the potential ups and downs of startup investing?
Well, I’m glad you asked.
One of the key factors to navigating this minefield of risk and avoiding investor paralysis is to make sure you always have a plan.
When you have a game plan and a working strategy in place, you won’t get pushed around by your emotions when you see a deal that looks good on the surface but doesn’t check all the boxes when it comes to your investment and strategy guidelines.
Also, remember that this is a long game and that startups will usually pivot their products. In fact, I was watching Shark Tank reruns with my son last night and there was a company update from their previous episode.
Famous angel investor Chris Sacca was a guest in the tank, and he took a chance on a baby-focused startup called Hatch. They had one product that was centered on changing tables for parents with youngsters.
Chris took the risk and committed $250k for a 3.3% stake of this budding startup. But after a period of time, the founding team noticed that the market wasn’t big enough for them to scale that product, so they pivoted and are now in the nightlight alarm business. This shift in their product marketing took them from $1M in revenue to well over $50M.
Click here to view full-sized image.
This is a great example of the risk that can come with putting your money in the hands of an early stage startup. In this case, the startup team had a plan and Chris made his decision based on the information he had available to him, though I’m sure Chris and his team conducted a much deeper due diligence dive after the show.
While Chris initially invested in a company that produced a great baby-changing table, the startup team had to make a decision and a major pivot to ensure the lasting success of the company.
As a seasoned angel investor, my guess is that Chris approached this entire deal like all his others — with the knowledge that it could fail … but having enough confidence in his investment strategy to go through with it.
The longer you're in this space and continue to craft and build on your investment strategy, you’ll gain the same amount of confidence to go through with a deal that you know has true potential.
A final note on risk: It's really important to understand your risk tolerance. Whether you love risk or you hate it, having a strategy will help you decide if you want to take on that risk or not. It’s all about having a game plan and a deep knowledge about the kind of investor you are.
Factor No. 2: Knowledge Is Power When Investing
Investor Peter Lynch said, "Know what you own, and know why you own it."
As I’ve watched this space over the years, I’ve seen deals and startups get millions in funding that I personally believe never deserved it in the first place. Often, when I see a startup skyrocket in funding and their rounds fill up quickly, it's usually because someone on the team is a good marketer.
Now, I'm not talking about the startups that are actually strong in both revenue and traction. Those firms are winning in their space and just need that $1–5M to scale to their next level of growth.
I’m talking about those deals that don’t have a strong leadership team, are pre-revenue, don’t have a solid plan and don’t even know if the market wants what they have. Typically, their marketer knows how to spin a good story, and the retail investors come running to fund something that either sounds too good to be true or pulls on the heartstrings.
Often, most of those investors haven’t done their research and don’t know much about the startup or even the sector it’s in.
In short, they don’t have the knowledge or information they should BEFORE turning over their hard-earned dollars.
And the part that really drive me crazy is when “the crowd” comes flooding into a deal only because they see others doing it.
They see a startup that’s gained funding traction and figure, “If it’s good for these 3,000–4,000 other investors, there might be something there and I need to jump in, too.”
The FOMO — fear of missing out — kicks in, and they jump into the deep end without really doing the work that needs to be done beforehand.
At the end of the day, when it comes to startup investing, it’s always smart to gain as much information and knowledge as you can on a startup before you invest.
I know that sounds pretty obvious, but you’d be amazed at how often investors get distracted by the shiny lights a good marketer shows them.
Get as much information as you can and before you click that “invest” button, try and gain just a little bit more. Knowledge is power and peace of mind.
Factor No. 3: If You Don't Know What to Do, Do the Opposite
Sir John Templeton, one of the greatest stock pickers of all time, famously said, "The four most dangerous words in investing are, it’s different this time."
I’m not sure about you, but in my life, I love to learn the hard way. In our household, my wife and I have a saying for when we find ourselves in a situation that didn’t quite pan out the way we would’ve liked. It’s a simple idea, but it has really worked for us.
If ever we’re faced with a parallel opportunity, and we don’t know what to do or the best step to take ... we just do the opposite.
A few years ago, my time was ending with an organization I worked for, but I was going to do the opposite of what I had done in the past when leaving a job ...
I was going to keep my expectations low and postured myself with gratitude for my time there and celebrated the growth I had experienced under their leadership. While there were certain parts about the organization that I didn’t agree with, this time was going to be different.
And it absolutely was because I chose to do the opposite of what I had done in the past, and it yielded opposite — and much more positive — results.
Now, the same can be said about startup investing. Let’s say you fall in love with a sector or a particular startup and have convinced yourself that it’s the next big thing in the organic dog food sector, for instance.
They tell a great story, collect your money and now you’re a shareholder in their company. Then, you find out that the company doesn’t really gain traction and is bleeding its capital dry.
You’d be surprised how often our desire to be right about a bad investment turns into crazy decisions down the line. You might even consider investing in the company’s second round, believing that this time around, it’ll be different.
Whatever the reason, it's amazing how we can talk ourselves into doubling down on an initially bad investment decision.
As we grow in our investing journey, especially in the private markets, it’s good to always be honest with yourself. Do what you can to step back and review your investments closely to see if they’re growing and gaining traction.
And if they aren’t, be willing to count it as a loss. But if you’re too attached to a sector or a particular startup and you need a mantra to guide you, my suggestion is: Do the opposite!
Of course, there are way more than three factors to consider, but I wanted to cut it down to these three for today. If our mindset, game plan and knowledge aren’t there, then we run the risk of making decisions we might regret down the line. And I just don’t want that for you.
Editor, Deal Hunters Alliance