Investing in Startups: Here’s all you need to know

Investing in start-ups can be tricky and complicated. It is important for investors to understand the value they can bring to the table as well as their risk appetite.

Startup investing is more than just investing your capital.

Being an entrepreneur is a mindset. You have to see things as opportunities all the time. I like to do interviews. I like to push people on certain topics. I like to dig into the stories where there’s not necessarily a right or wrong answer. – Soledad O’Brien

In her book ‘Mindset’, world-renowned Stanford University psychologist Carol S. Dweck observes that people with a fixed mindset—those who believe that abilities are fixed—are less likely to flourish than those with a growth mindset—those who believe that abilities can be developed. This Growth Mindset is the single biggest reason why entrepreneurs have built the world’s third biggest ecosystem for start-ups in India. The start-up ecosystem which started with a few entrepreneurs, grew to a handful, to many clusters across the world today supported by an ecosystem that challenges the status quo for a better tomorrow, no matter which field they straddle.

Let me explain this with a cricket analogy. In the cricket World Cup played in 1996, Sri Lanka turned a motley bunch of bits and pieces cricketers into the most invincible team in the history of the game. What they lacked in skill, they more than made up with belief and gumption. They cultivated match-winners and world-beaters within the space of two years ago by charting a course, sticking to the strategy which entailed everyone played well defined roles, complementing, and backing each other. The same thing happened with Australian cricket team under Alan Border in 1987 and the Indian cricket team under Sourav Ganguly in 2003. They all had one thing in common – a bunch of young, enthusiastic players thrust on to the world stage with confidence, never say die attitude and a growth mindset. It helped that they were all start-ups.

“Change is hard at first, messy in the middle, and gorgeous at the end” – Robin Sharma

The same attitude is enabling entrepreneurs script an equally spectacular success story among start-ups. Investing in start-ups can be tricky and complicated. It is important for investors to understand the value they can bring to the table as well as their risk appetite and accordingly choose at which stage they would like to partner with the entrepreneur and size the investments in the portfolio accordingly. E.g. Earlier the stage, smaller the relative per company investment and more the number of companies in the portfolio. In a way that brings down risk, but also lowers the success ratio. According to American investor and start-up founder Romeen Sheth, investing in start-ups is a cheat code to participating in the future with asymmetric upside. Worst case, you lose 1x your money. Best case you 1000x it.

Investing in start-ups can be considered high risk from a purely financial standpoint. >50% of your portfolio of companies (especially in early stage) may lose you all your capital. But your top 5-10% may deliver super normal returns that may lead to handsome portfolio IRRs. But in both, there are seldom losers. In fact, the impact you would have created by investing in and backing the right entrepreneur who may not have delivered you returns in your portfolio now, is much bigger as he/she will very likely be the one featuring in the top 5-10% of your future portfolio.

There’s a lot of noise about how there’s too much capital sloshing around. I think there isn’t enough capital moving around. To believe the ecosystem is overcapitalized is to believe that human creativity is fully tapped – Romeen Sheth

Start-up investing is more than just investing your capital. It is about reimagining the future. It is about building for a sustainable future. It is also about the positive impact you can create to the eco-system beyond your capital. Capital is just one piece of the puzzle.

“Silicon Valley is a mindset, not a location.” – Reid Hoffman, Founder, LinkedIn

It is important to remember that there are no set rules for start-up investing. You must pick up the skills while being on the job. You must be a lifelong learner. Either you have to build something or fix something and no amount of Ivy League education will teach you that. According to Naval Ravikant, the most valuable start-up of the last decade didn’t raise money, didn’t have employees, gave away the cap table, and let anyone invest.

Unless you are into paediatrics or developmental medicine, aging should not be seen using the distance from birth, rather through the estimated distance from death – Nassim Nicholas Taleb

Investing in Start-ups: Winning ≠ Success; Losing ≠ Failure

Here are a few handy pointers to pick the right partner:

Does he/she have a growth mindset? Is he/she a dreamer and a good and inspiring storyteller?

Does the problem statement have potential to create a tangible impact to a large user group?

Does he/she have a single-minded focus in execution to achieve the vision of the company come what may?

Many times, especially in later stages, investors may not be able to access the founder as he/she is busy building a business. Hence it is not a bad idea to work with institutions and seek access through funds that aggregate likeminded capital and funnel it to the businesses. In either case, an investor will always be successful whether winning or losing in individual portfolio investments.

This is hard. This is fun. – Carol Dweck

(By Alok Saigal, President & Head, Private Wealth, Edelweiss Wealth Management)

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