This is the first article in a 3-part series about startup portfolio management.
It is never too late to develop a plan for your startup investment portfolio — whether you are creating one for the first time or updating one that’s already in place. A portfolio plan is a critical first step before figuring out your investor strategy and investment thesis (which we will talk about in a follow-up articles). The good news is making a portfolio plan is not hard, and I am going to walk you through a simple approach today.
First, a little reminder and reality check. Start-up investing is a long-term, high-risk endeavor. Assume you will not see a return for 10 years and that for some investments the return will be zero. You’ll need years of patience, perseverance, and commitment to be successful. With that out of the way, let’s get down to it.
1. Decide how much money (capital) you have to work with. I already mentioned that your investments will be illiquid and carry a high risk of losses, so do not invest any money you cannot afford to lose. One rule of thumb is that your start-up investment capital, including crowdfunding, angel, and venture investments, should only make up 1-5% of your investable assets available over the next 3 to 5 years. For many of us our investable assets are stocks, bonds, ETFs, mutual funds, real estate (REITs), and a portion of our cash savings. Exclude the value of your home, cars, and cash reserves needed for bills, expenses, and the unexpected. For the sake of discussion, let’s say we are just starting out and have $10,000 that we are able to allocate to crowd investing over 3 to 5 years.
It’s worth noting that the SEC prescribed upper limits for investors are actually more aggressive than I recommend. Their limits allow an individual to invest up to 5% or 10% of their income or net worth each year, rather than in total. Specifically, the SEC limits the amount an individual can invest on a rolling 12-month period to:
- 5% of annual income or net worth, if either is less than $107,000
- 10% of annual income or net worth, if both are greater than $107,00
2. Plan the number of companies you need to invest in. I say “need” and not “want,” because it is necessary to invest in a large number of companies to ensure you are building a diversified portfolio. As the Venture Capital industry has shown, you can expect the majority of returns to come from a small number of your investments, so increasing the number of companies you invest in gives you more chances at having a major winner in your portfolio. Generally speaking, that means committing to a minimum of 20 to 30 companies. Over your investor lifetime, you may want to set a goal of investing in 50 or 100 companies. Continuing with our hypothetical portfolio, let’s commit to investing in 25 companies.
3. Standardize your “initial” investment amount. Based on our $10,000 of capital and commitment to invest in 25 companies, we can invest $400 per company. We’ll adjust this amount in a minute, but the important thing is to standardize your initial investment amount and stick to it for all 25 companies. This eliminates the potential trap of making a case-by-case decision about your investment amount, as we are all susceptible to emotions and subjectivity. If you come across a company that you love and want to put more into it, that’s great! Stick with the $400 though. Growth is expensive, so if the company is as good as you think, they’ll be back to raise more money and you’ll get to see how they perform between now and then.
4. Reserve capital for “follow-on” rounds. After making an initial investment in 25 companies, monitor their performance to see which fail, which scrape by, and which look like winners. As you see the winner’s emerge, you will want to double- or triple-down on these companies. This is another reason for being disciplined with your initial investment. Thus (much like a VC), we need to reserve 30% to 50% of our capital for follow-on investments. I recommend erring toward the high side and reserving 50% of your capital for follow-on investments. You can always reallocate it later if you’ve over-reserved. So, we will reduce our standard initial investment from $400 down to $200 per company, so that we can make 5 follow-on investments of $1,000 a piece.
- Initial Investments of $5,000 = 25 companies x $200
- Follow-on Investments of $5,000 = 5 companies/rounds x $1,000
5. Take your time putting your capital to work. The combination of bold start-ups with impressive technology, inspiring missions, and large potential returns might tempt you to invest in a lot of companies quickly — especially if you know you have to “get through” 25 before you can take the training wheels off. Please don’t. Remember, we targeted 1-5% of your investable assets available over the next 3 to 5 years because that’s about how long it may take to make 25 quality investments. Take your time, be selective, and do your research before committing your money. After all, we are just starting to build a portfolio and are bound to make mistakes. Instead of tracking your progress based on the number of companies you’ve invested in, base it on the number of companies you’ve reviewed. The more practice repetitions you get, the more you’ll learn, and the better you’ll get at making investment decisions.
6. Finally, learn from the mistakes of others. It’s often faster and cheaper to learn from the experience of other investors. Much of the advice above is based on lessons I have learned the hard way. You can also find sage advice in a couple of books from two prolific start-up investors, Angel by Jason Calacanis and Angel Investing by David Rose.
Good luck and welcome to start-up investing! Check out the second article in this series on investor strategy.
For the equity crowdfunding portion of your investments, you can use KingsCrowd’s Follow and Portfolio Management tools to track and manage your current and prospective portfolio companies.
Wall Street has Morningstar, S&P, and Bloomberg
The equity crowdfunding market has KingsCrowd.
About: Mike Cozart
Mike is a senior product leader and angel investor. Mike started his career as an investment banking analyst and venture capital associate before taking on general management and product management roles with Amazon and Axon Enterprise. He earned an MBA from Columbia Business School in New York City, a BA in Economics from The University of Texas at Austin, and a BS in Geographic Information Science from Texas A&M University at Corpus Christi.