Note: This is a guest piece from our friends at Early Investing. We talk a lot about how new and exciting startup investing is — it’s one of our favorite things about it! But sometimes you want to hear from someone who’s been around the block a few times. This piece offers some grounded advice that’s based on more than 100 investments. We hope it helps you avoid pitfalls and make smart investment choices.
This piece was originally published by Early Investing on August 28, 2020.
I’ve been investing in startups online for six years now. I’ve made small investments in more than 100 companies so far. I’ve also been part of three funds which invested in another 32 startups.
Today I’m going to share some of the key lessons I’ve learned — often the hard way — since I started.
Early on, I invested in a few companies primarily because I was excited about the idea and the size of the market. This is almost always a mistake — especially if the company doesn’t have promising traction.
For example, one of the companies I backed in my first year made software to manage apartment complexes. “What a huge market,” I thought. At the time, the company only had 1 or 2 customers. But the software demo looked pretty good, so I decided it was worth a shot. The company failed within a year or so. The same thing happened with a few other similar startups I invested in.
I learned an important lesson. Don’t bet on companies just because they have a good idea that fits into a big market. That’s not enough. Ideally you want to see good traction. My best investments had promising traction and growth when I invested.
These days, the only time I break this rule is if I’m investing alongside a top-tier co-investor — venture capitalist or angel investor — whose judgement I trust implicitly. Then it might be worth the risk.
Be Wary of Big Names
In my first year of startup investing, I invested in two companies primarily based on the fact that they already had some very big-name customers. One of them was a seed-stage startup which already had notable clients like Disney as customers.
I was so impressed by the big-name clients that I overlooked the fact that they only had a tiny trickle of revenue coming in.
Since then I have been wary of startups that place too much emphasis on a few big name customers. Big clients aren’t a red flag by themselves. But they are a reason to dig a bit deeper and look for solid traction first. If a company has impressive clients but little revenue to show for it, it’s likely not the strongest investment you could make.
Don’t Invest Based on Industry
I mention this point frequently. But not investing based solely on industry is so important, I’m going to spend some extra time on it here. As online startup investors, we only have so many deals to choose from. Venture capitalists can go out and compete for any deal they want. They can be picky about industry. We can’t.
Like the other lessons, I learned this one the hard way. In my first few years, I invested in a few deals just because they were in “hot” industries. If you’re going to invest in a deal in a hot industry, make sure there are other factors which make it attractive.
If you’re really excited about a particular industry, then look for deals in it that have solid traction. Or that have founders with relevant experience and/or a strong track record. You might not be able to find all of these traits in one company. But you should still try to pick deals that have a lot going for them — not just an attractive industry.
Spread Out Your Bets
The first three tips I listed can be summed up as: look for traction and be picky. But you also need to spread out your bets across a bunch of startups.
Fortunately, this is easier to accomplish than ever. Equity crowdfunding has grown significantly since it first launched in 2016. I mentioned a few weeks ago that there were more than 300 live deals out there. That number is even higher now — according to Kingscrowd data, there are 390 live deals!
So it’s easier than ever to both be picky and to diversify across a bunch of opportunities. How many startups should you aim to invest in? That’s up to you — but we recommend at least 10-20 to give yourself a good shot at hitting a big winner.