How To Invest in Startups

This is Mr. Cranky’s Official Guide on How To Invest in Startups. Now a better topic than How To Invest in Startups would be Why The Hell Would You Want to Invest In Startups but that’s another article. Also, a warning. These are my opinions, based on experience as a limited partner in Venture Fund and an Angel Investor. Do not make investment decisions based on this article! Got that? It’s just observations of the various choices and the relative benefits and pitfalls of multiple investment methodologies.

No primer on how to invest in startups would be complete without a primer on the state of Venture Capital. Venture Capital Investment today is divided into the Haves and the Have Nots:

  • The Haves (THs) – a group of venture funds who raise money from top financial institutions and endowment funds. The THs don’t have to actively go out and raise money, there’s a long line of Limited Partners ready to invest well over $1 million dollars in the fund to get access to the “best deals.” If you’re reading this to learn something, you can’t invest in any of THs. THs get access to the best deals and in order to limit competition for Limited Partner Investors, THs elbow out second-tier funds (The Have Nots) out of those best deals. Who are they?
    • Accell
    • Andreeson Horowitz
    • Battery
    • Benchmark Capital
    • Bessemer
    • BVP
    • First Round
    • General Catalyst Partners
    • Greylock
    • Founders Fund
    • Khosla Venures
    • Kliener Perkins
    • Lightspeed
    • New Enterprise Associations (NEA) – The only TH with a local presence.
    • Norwest Venture Partners (NVP)
    • Redpoint
    • Sequoia Capital
    • Spark
    • Union Square Ventures
  • The Have Nots (THNs) – The second and third tier funds. Often requiring a minimum of $100 investment from Limited Partners. THNs get access to leftover deals that THs don’t want or for some reason can’t find. Sometimes THs will find a diamond in the rough. In this town, the THNs are dropping like flies in a Raid factory. Some of the local DC-based dead:
    • Disruption
    • FBR
    • Fortify
    • Novak Biddle
    • Valhalla Capital
  • Proof VC Proof VC is engineered to get access to exceptional deals. Proof partners with top accelerators. When an accelerator has a potential unicorn, THs typically swoop in and invest. The accelerator that originally invests in the seed round of a startup typically obtains anti-dilution rights that would allow them to co-invest in the Series A rounds alongside a Top Tier VC. Most accelerators don’t have the capital to invest in the later stages of their portfolio companies rendering the anti-dilution rights useless.  Proof camps on to the accelerators rights and then shares any carry (profits) from a positive exit with the accelerator. This results in a win/win for the accelerator and Proof. Proof gets access to deals of which they would typically be elbowed out and the accelerator gets upside from their unused non-dilution rights (you can read more about Proof VC Here).
  • Private Access Network (PAN)PAN is a modified Angel Group. Unlike most angel groups, PAN members only see deals that are curated by PAN’s two founders. The founders only present companies when they decide to invest their own capital in any deal they present to the members. They have skin in the game. Like a typical Venture Fund, PAN has a disciplined approach to investing. They follow strict guidelines when selecting an investment. They never lead, they only co-invest. They don’t invest in pre-revenue companies. PAN doesn’t compete for the type of limited partners that VCs seek as investors. Because VCs don’t view them as a competitor they invite PAN to participate in good deals. PAN offers access to top tier deals co-investing with THs. They charge a membership fee of $1,000 per year and there is no requirement to invest in any deal. PAN members choose if and how much they will invest in each deal. The access to top deals does come at a cost… PAN members pay a carry while Angel Investors do not (you can read more about PAN Here).
  • Blueprint EquityBlueprint a traditional VC in every way but one. Blueprint scours a large universe of companies that would be overlooked by traditional VCs. Their target investments are located in towns where few VCs hunt. They look in out-of-the-way geographies for bootstrapped companies, that are profitable or cash-flow positive. They only invest in B2B enterprise-focused companies. They look for companies that have proven product-market fit, a working business model. Blueprint invests in companies they believe would benefit from a cash infusion that would drive exponential growth. These guys are not shooting for grand-slam-unicorns. They’re shopping for reliable workhorses. They’re stepping up to bat and looking to hit doubles and triples.  Their playing for a high batting average and not for slugging percentage (read more about Blueprint Here).
  • Angel Group Investing – A group of investors who hunt together and write checks individually. The better the group, the better the deal flow, the better the deals that get presented to the group. In the DC area, there are several good Angel Groups including:

Do you want to invest in startups? Want to know how to invest in Startups? Here’s a synopsis of your choices:

So how you make a choice? Some factors to consider:

  • The Haves (THs) – Forget it. Unless you’re a billionaire… you aren’t getting invited to invest in one of these.
  • The Have Nots (THNs) -If you want to brag to your friends that you’ve invested in an institutional Venture Fund and you mind losing it all… go ahead.
  • Proof VC -If you have at least $100 thousand to invest, and you want someone to manage your choices. Proof VC offers a proven team, with proven results, and has cracked to code on how to invest alongside THs.
  •  Private Access Network (PAN) – PAN invests alongside NEA and other big name VCs. If you want the flexibility of investing as little as $10 thousand in a deal and you want to actively decide on which deals you invest, Randy Domolky and Scott Schedler’s PAN is your ticket. As a PAN investor, you get to tell people in cocktail parties that you invested in the next UBER and not the next Trustify or Speek.
  • Blueprint Equity – While there is no history to back this up, Blueprint’s strategy should portend to low risk. While most VC’s count on 20% of their portfolio to hit the ball out of the park to make up for an 80% failure rate. Blueprint is looking for a low failure rate and rational growth.
  • Angel Group – Want to make seed investments in early-stage companies? Angel Groups offer deal flow of companies too early for traditional Venture Capital.  That early stage means a high failure rate so you’re going to require a big return to make your number. Another advantage of angel groups is that you hunt in a group. You can share the burden of due diligence.

How to invest in Startups? How the hell would I know? In 1999, I made a $100 thousand commitment to a venture fund, FBR II. FBR drew down $93 thousand of that and returned $7K. Not exactly stellar and yet, in their defense, FBR I was a grand slam (as was every fund founded in 1995/97) and as far as FBR II is concerned, investing in startups in 1999 would be like investing in the Dow Jones in 1928 and closing out the investment in 1932.

Over the Period of 2008 and 2013, I made 10 angel investments. Two of them, Social Tables and Veenome had a positive return. One of the companies in which I invested is still a healthy company but I’m not expecting it to make a significant return. In 10 years, my Angel portfolio had a positive return of 57 percent. In that same time frame, the S&P returned 90 percent. I took a lot more risk for 1/2 the return. I caution people who want to know how to invest in startups, that my return was extremely lucky and not typical for an angel investor. I could have made more money at lower risk if I had invested in the S&P or real estate.

Considering maximizing financial return was not my top priority, I can’t complain about my history (see why I invest here) Before you invest, examine why your investing, what are your goals, your risk tolerance (can you lose it all without losing sleep) and do you have the discipline to manage your own portfolio. Then choose your poison.