How can I minimize risk when investing in startups?
No matter what, startup investing will always come with lots of risk, including the possibility of losing everything, so you have to be prepared and able to assume total loss. However, there are some things that will help reduce some of the risk:
Invest a small portion of your investment capital (less than 5%) in startups. And definitely no more than you can afford to lose. The capital that you invest in startups should be considered 100% discretionary as startup investments are long-term (up to 10 years before returns are realized) and often result in a total loss of investment.
Invest in many startups so that your risk is diversified. Create your own portfolio of startups to help spread out the risk among many investments. Instead of investing your entire startup investment budget in one company, consider investing in 8 or 10 companies. The rule of thumb is 1 out of 10 companies succeed so by diversifying your investment, you increase your chances of success.
Create your own investment thesis. It may seem daunting to pick one startup to invest in, let alone a whole portfolio. Generating an investment thesis can help guide your decisions about which startup deals to consider. It doesn’t have to be a complex thesis, either – observe the trends in the market and do some research before formulating an opinion on what the future may look like. If you believed that collaborative consumption would take off, you might have invested in Airbnb and Lyft. If you believe that disintermediation is changing the way individuals buy, sell, trade and interact, then you might consider investing in companies like TaskRabbit, Uber and Kitchit. If you believe that subscription services are here to stay, you could consider Birchbox, Dollar Shave Club, or Blue Apron. Once you begin searching for the startups that match your thesis, you will find a wealth of opportunities.
Invest with 2-3 friends or co-investors. If you establish a rule that you must all approve the investment before you proceed, you’ll have additional sanity checks to help you make informed decisions on the startups that could make great investments.