Three Big Things the Media Gets Wrong About Startups

What the mainstream media dislikes about investing in startups isn’t surprising.

A lack of transparency. Almost no liquidity. And most metrics investors rely on nowhere to be found.

I talked about these things in this post I wrote before Thanksgiving.

A lot of people are drawing the wrong conclusions… that investing in startups is too hard. Too risky. And too complicated.

How can investors possibly overcome these negatives?

It’s the kind of rote thinking that keeps individuals away from this very lucrative new investment space.

But this line of thinking couldn’t be further from the truth. Each of these so-called flaws or drawbacks can be turned into an advantage, as I’ve explained.

My more optimistic view isn’t some pie-in-the-sky opinion or based on outside research. It comes from our own experience of building a successful startup portfolio.

Adam and I have mostly targeted seed-stage companies. They’re doing fine. Several are doing much better than fine – far exceeding their targeted milestones and getting much higher valuations (for those that have gone on to do another round of fundraising).

In this recent post, I promised that “I’ll show you how we do it.”

Three Startup “Flaws”

Lack of transparency. Founders aren’t part of a secret society. Nor do they hide from the press. (In fact, founders love publicity, mainly because it’s free – a big plus for very small companies with modest cash resources.)

But access to information is limited and uneven compared to public companies. Very few filings with the SEC are required. A startup’s deck is often sent to individuals on a “confidential” basis. Valuations are negotiated behind closed doors.

There’s no denying a lack of transparency. But we’ve made it work to our advantage.

We talk directly with the founders. Also talk to the customers. And competitors.

And we do our homework. Evaluate a company’s deck and other material given to us. Get clarifications and additional information where we see gaps. And analyze the markets, technology and growth strategy.

I’m pretty sure we do more than the vast majority of investors. Our response to a lack of transparency thus becomes our edge.

Our approach isn’t unique. But it’s harder to do than with public companies. Warren Buffett spends an enormous amount of time with a public company’s management team.

But who has his access?

Startup investing is a different animal. Silicon Valley is not Wall Street. And there’s more than one way to skin a cat.

Take an angel investor I met on AngelList (and whose syndicate I invested in): Paige Craig. He gets to know founders by partying with them. I’m not kidding. But he is a very serious and successful investor. His portfolio includes Lyft, AngelList, Postmates, Twitter and ZenPayroll.

Virtually no liquidity. Once you invest, you probably won’t be able to cash out your shares for years. The journey to an IPO takes eight to 10 years.

A buyout can happen at any point of the journey and they’re much more common than IPOs. But they’re also hard to predict. They can just as easily happen in the seventh year as the second year.

So whether you like it or not, you’re investing long term.

Myself? I like it (as does my co-founder Adam). If your startup is going through a rough patch, guess what? You’re not agonizing whether to sell. Or, at the other end of the spectrum, if your startup just raised its valuation by 10X, you’re not tempted to sell (and miss out on a possible 100X return!).

This is a very good thing…

People tend to sell low out of frustration, impatience or a fast-falling belief in the company. Can’t do that with startups. When you’re in, you’re all in… for the duration.

Researching companies without most metrics and hard data. The amount of research or due diligence you do matters. In fact, it matters more without having key metrics to check.

You have no inflated PEG (price to earnings divided by projected annual growth) numbers to shoo you away. Due diligence takes time. No shortcuts here.

So I’m not surprised that the time you take to do due diligence is a predictor for success. Your odds of getting outsized returns increases for those willing to put in the hours.

Take a look at the chart below from the Kauffman Foundation…

The “high diligence” investors have a slightly better chance of getting returns between 5X and 10X than the “low diligence” investors.

But if you’re aiming for returns above 10X, high diligence investors significantly increase their odds. And only the high diligence investors enjoy returns of over 30X.

The low diligence investors? They’re completely shut out.

You Don’t Have the Time? 

But what if you don’t have 40 hours to dig into a startup opportunity. Then you need to find sources you can trust and follow.