The startup term is very trendy recently, all new businesses call themselves startups, even if they are not? By Wikipedia definition:
Start-ups (early-stage business in Hungarian law) usually mean recently established companies with a high growth potential, most of which are engaged in product or business model innovation. These companies have set their target on international markets, so they are not focused solely on the local market. High growth potential is basically meant for international startups, so international scalability is a particularly important element of the definition.
However, the most important question for an investor is how can I make a profit from it and how can I maximize the return on an investment?
In my previous post, I wrote about Microsoft’s growth. At that time we could say that the company’s stock price increased by 32837% in 30 years. Let’s think that if we only invested $1,000 in Microsoft 30 years ago. At that point, it was meant to be a startup, and now our investment would worth $328,000. I think a lot of people are dreaming about having such a luck. Of course, there must be a great deal of perseverance not to get out of this investment for so long. It was no accident Bill Gates became the richest man in the world.
Of course, who could have predicted that Microsoft would be so successful and that it would get so far. How many people were able to determine from the very beginning that Microsoft will conquer the world and most people will use its operating system. Well, not so many. I don’t think it can be determined in a scientific way. Rather, it is an art is to find such a successful company. Otherwise, everyone would be able to build a successful company.
Why people are investing in startup businesses?
- Potentially market returns are significantly higher
- They think they can help their development and can make the world better
- They want to look smart if one of their investments turns to be excessively profitable
- In the long term, they think it’s better than investing in stock market shares
- They want to diversify
- They want to get inspired
- They want to learn
Some people already achieved a nice return with their startup investments, and can hear more and more successful people that after selling their own company, they establish an angel investment group in a company with other investors. They do not prefer big global companies, they do not buy government bonds, they are looking for startups with great potential. For example, Ahston Kutcher has invested in Hungarian-founded Bitrise, and he shares why he invests in startups and what his strategy is. Or Peter Thiel, a former Paypal founder (together with Elon Musk), who has already funded a bunch of startups.
Because the vast majority of people do not own a company that they could sell for hundreds of millions or billions of forints, they have to look for another way.
Until recently, there were strict rules on startup investments at a global level, fortunately these barriers have now disappeared and an adequate number of equity crowdfunding companies have been established. I think SeedRS and Crowdcube are the most accessible and understandable for the Hungarians . Both of them operates in the United Kingdom, but start-ups from other countries are also available on their platform.
Startup Investment Strategy
To summarize my strategy:
Never invest any money in startup companies, which’s loss hurts. Take the responsibility of losing that money. There is a huge potential that your investment will be lost. If you lost some money on an investment, then learn from it and move on, don’t panic.
My advice on startup investments is as follows
- Invest into an existing and operating company, do not invest into ideas.
- Do not focus on one company, but try to build a broad portfolio
- You should always have a reserve to invest in the next startup
- Invest only in a company you believe you understand how it works
- Help them with your network or your knowledge
Diversify
Diversification can never be stressed enough. Think about how many businesses starts in Hungary every month (thousands), how many winds down (thousands). Think about how many will become successful, that is to say they will reach such an increase that they can even enter the international market. Not many. Hungary is not famous about entrepreneurship. Other countries with huge entrepreneurship community it is even worse. But then how many companies should we invest in, and how much capital should we start with?
SeedRS / Crowdcube set the minimum investment to 10£, but often a single share is more expensive, at least 1 share investment is required. I think it’s worth targeting at least 100, but it’s better to target at least 200 startup companies. If we count only 10£, it is 1000-2000£. I think it is not advisable to start with this small amount, I would suggest to start with at least 10,000£, and the sum amount should not exceed 10% of your savings. Don’t invest into all the startups, I would suggest to choose wisely. Selection criteria:
- Companies after numerous raises have a much better chance of survival than those which are raising for the first time. It is often said that companies over 4 capital raises are very likely to succeed. Those who are in the first round may have a better return, but the risk is much higher.
- If we see a big investor beside a company, and it is public who/which company is the big investor, we can find out how serious (professional / financial) investor it is. (eg. how many startups have been funded so far and how successful they were)
- It may be better to avoid declining industry (eg. renewable vs. non-renewable energy industry)
- If it is not clear where the revenue/profit will come from
- CEO/owner’s motivation, find out if they would like to use the raise capital for their own salary
- How long the freshly invested capital will last, money burn rate
- Check the reality of their cash-flow plan
- Is there something unique in the idea or just a copy of another
- Transparency
- Management experience in the company’s field
- Purpose of capital raise
Be patient!
As startup investments are not short-term anyway, it is unnecessary to worry about how a company will develop in a few months. Often the original product is very different from the final product. Good startup is always capable of change, recognizing what does not work and developing its product / service accordingly. Don’t be surprised if you invested in apples, but you get pears.
How do I get out of a startup investment?
Exiting from a company is never straightforward because you need to find someone who is interested in buying your shares. For startups, these options are:
- Buyout from another company (eg via Instagram Facebook)
- Initial Price Offering (IPO)
- Another investor group buy-out
If neither happens and then company stays private in the long run, you may still have the opportunity to make money from our investment:
- Previous investor would like to further increase his / her stake / influence and seek sellers
- Share buy-back
- Dividend payment
The last one is the least likely, a growing company is not expected to pay dividends for decades, as Microsoft still has very low dividend payment ratio after 30 years.
I’ve been involved in 66 raises since 2016 and I’m very happy with the results.