This article by Herty Tammo was originally published by Äripäev in Estonian, we’ve translated it to share the knowledge with everyone!
Having learned investing in Silicon Valley (Kauffman Fellows) and doing it actively since 2007, I’ve now invested in more than 200 early-stage startups and exited 10 businesses. Lately, I’ve found myself repeating my thoughts on the topic to people who ask for tips about investing in startups.
More and more we see incredible success stories where early investors of Bolt, Transferwise, or Pipedrive get huge returns. We find ourselves thinking why we don’t do the same. And yet we know that the majority of startups fail. Is it even worth it then? The answer is simple – yes, around 10% of your personal investment portfolio should be in early-stage startups.
But how do you start investing in startups?
There’s multiple options. For starters, you could try your hand out on some public investing platforms such as AngelList, Seedrs or Funderbeam. There you can gain experience with smaller amounts and see if your choices are right.
It is also possible to join an angel investment group such as EstBan in Estonia or DanBan in Denmark. These groups put together syndicates, where 10-50 investors invest together in one start-up company, for example, each putting 5,000 euros. Both of these approaches are good ways to learn.
Smart money leads to the best deals
However, for more serious investments, your portfolio should have at least 20 companies to diversify risks. In order for venture capital math to work, there should ideally be as many as 100 companies.
The startup founders want to raise so-called smart money. They want to know who you are and how you can help them. You can get into the best deals with your own knowledge. The performance of your portfolio may remain quite modest if such deals are not shared with you. In order to have these deals shared with you, you need a good reputation and a brand. It generally takes time to develop those, unless you are a famous startup founder, who is idolized by other founders.
However, once you finally get to the point where you get to see many good deals, you’ll need to review about 50-100 deals annually. From there, you choose 4-7 where to put your money. After having found the ones you see with the greatest potential, you need to perform due diligence (DD), followed by legal work. Both you and the founders need those to make the right agreements that protect your interests.
Lots of work and emotions
After making an investment, you should expect to receive monthly reports from the startups. It often includes ways how you could help them more. As a smart investor, you should do that. Founders ask about you from other startups you have already invested in, whether you also brought added value to the table. After a while, the founders will raise another round of investments. Then you need to decide whether you want to invest more or not. If new investors want to buy you out, you have to decide whether to sell or not. This question, of course, arises only when all goes well.
However, as most of the time, things do not work out, your money is burned out and the startup has to be liquidated. That’s when you and your co-investors need to manage your emotions. In the process, you must not quarrel with the founders, as they may be the ones who give entrepreneurship another try and make a unicorn like Pipedrive. By pouring out your incompetence on the founders (Eesti Ekspress 2010), you can be sure that you will not be invited to invest in Pipedrive afterward.
It’s all the work you need to do to make angel investments correctly. If done well, it will take about 75-110% of your time. Are you ready for that?
Are there any alternatives?
Of course. If you have a lot of liquidity and the 10% of your assets that you have decided to invest in startups are large enough (5+ million euros) you can hire a team to do it for you. We already have these examples in Estonia, such as the Kristjan Rahu fund Lemonade Stand, Taavet Hinrikus’s Notorius and some more.
However, if this is not for you, you have the option of joining a trustfund as a limited liability partner. By investing in the fund (min. 100 000€), you have a professional team – who already have a brand, experience, network and people – do the work for you.
The remuneration of such a team is on average 2% per year and in case of success about 20% performance fee. They work hard to earn your money back by 2-5 times. There are no guarantees, but good brands and teams do succeed.
Those funds are usually 10 years old and invest in at least 20 startups. If this hands-off approach seems too boring for you and you would like to interact more with the startups yourself, you can always ask the fund team for the right to invest at your own choice. This way, it is possible to build a high-quality portfolio with sufficient diversification and not spend more than a few hours a week on investing in startups.