How to Find Your Own Winning Private Early-Stage Opportunities

How to Find Your Own Winning Private Early-Stage Opportunities
By Andy Gordon
Date July 18, 2016
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Equity crowdfunding is different from public sector investing.

But with just a little information, investing in startups can be easy and fun…

Especially when you do it alongside us.

We’ll do most of the heavy lifting, tracking dozens of positions on our watch list.

And then we’ll pass you our comprehensively researched recommendations… saving you time and making you a smarter investor.

But what about right now? What do you need to know to start investing in startups TODAY?

We obviously can’t teach you everything. At least not all at once. So our goal in this report is to give you some basic rules.

What we’ve done is boil down more than 500 pages of research – which we’ve spent the last two years compiling – into the 10 winning rules you should follow.

But before we get to those, there’s one thing we need to go over…

Knowing what equity crowdfunding is.

The Offspring of Two Worlds

Equity crowdfunding is an offspring of two worlds…

One world occupies the crowdfunding space. If you’re familiar with Kickstarter or Indiegogo, you know exactly what I’m talking about. These online sites list very young companies that are preparing to make products and need money from you (the crowd) to do so.

As compensation, you get a discount on the product and/or a gift like a T-shirt.

The other world that equity crowdfunding occupies is made up of venture capital firms. They buy private shares, or equity, of companies that need funding to continue to develop and grow.

In the past, everyday investors were prohibited from investing in these companies. They could only make monetary contributions.

But those rules were recently dropped. Now anybody – regardless of net worth or income – can invest in these young private companies.

Like original crowdfunders, equity crowdfunders go online to find these startups. And like venture capitalists, they buy the private shares or equity that enterprises offer at the early stages of their developments…

Hence the term equity crowdfunders.

OK. It’s time I laid out the 10 rules you should follow to invest smartly and safely in early-stage startups…

The 10 Rules

  1. Build a big portfolio. In a post I wrote for accredited investors in 2014, I said it makes sense to add 12 to 15 positions a year until you reach 30.

But again, that was advice for accredited investors, whose minimum investments are often $10,000.

So for most of us? It’s the more, the better.

Your limits will be determined by affordability, the time it takes to do a little digging into these companies, and the time it takes to keep track of them once you’ve invested.

Why a big portfolio? The more holdings you have, the better shot you have at a big winner. The First Stage Investor team (Adam Sharp, Vin Narayanan and yours truly) have written extensively about the “power law of returns” that describes this dynamic.

Click here for more details.

  1. Diversify. Just going big isn’t enough. Diversifying is also key.

For larger VC investors, it’s a choice, not a rule. Some very successful VC firms diversify, while others specialize by industry or technology. Either way, they make it work.

But unless you’re a VC or professional angel, diversifying is a must. There are lots of ways to do it:

  • By sector, industry or technology
  • By geography (e.g., domestic vs. international, Silicon Valley vs. everywhere else)
  • By type (e.g., service startups vs. hardware ones)
  • By fundraising round (if you prefer seed rounds, which are done under Title III, make sure to sprinkle in some Series A and later rounds, which are done under Regulation A+… and vice versa if you prefer later rounds).

Different rounds tend to have different risk and reward profiles. Read this for a great overview of some of the differences between seed and Series A rounds.

  1. Invest with emotional intelligence. Never invest out of a sense of desperation. If you need to make 10X gains in the next three months to keep the loan sharks away, this kind of investing isn’t for you!

Early-stage investing assumes and requires a long-term commitment. You need copious amounts of patience, as well as a determination to remain calm through thick and thin.

Do you have what it takes?

  1. Crawl before you walk. Please don’t go crazy and put all your investible savings into the first startup that strikes your fancy.

There’s no rush. You should give yourself three to five years to replace 10% of your portfolio with private shares.

  1. Only invest in what you understand. You don’t have to be an expert in everything you invest in, but you should at least have a passing familiarity with the businesses you select.

An easy way of doing this? Invest in startups with products you’ve tried and can’t live without.

Just remember: This is a nice starting point, but you should also do some digging to make sure the teams involved are top-notch and that the markets they’re addressing are big and growing.

  1. Look for founders with established track records. Granted, there are lots of examples of wet-behind-the-ears founders who go on to achieve spectacular success.

Mark Zuckerberg is a shining example. But remember that everyone who invested in Facebook’s early days had numerous long sit-downs with him.

Now, unfortunately, founders can’t grant one-on-one meetings to everybody. There are simply not enough hours in a day. But you can do the next best thing by watching videos of them talking up their products.

And, as Adam pointed out in this post, most portals will have a Q&A feature. Don’t hesitate to use that resource, too.

Most importantly, if founders have done this before, check out their previous track records. As you do so, look to see if their previous successes were in the same sector.

Many experienced founders move around. Sometimes they want to experience new challenges outside of their areas of expertise. That’s fine, but it does mean they represent a higher degree of risk than those who continue to operate in the same space they’ve already successfully navigated.

  1. Make sure you have two different sets of expectations. I know I already touched on this above, but it’s too important NOT to elaborate further.

The Regulation A+ companies you select that are raising money in Series A or later rounds should be much further along than your Title III seed-level startups. And you should factor those classifications in when judging what constitutes poor, acceptable or great progress.

In other words, don’t paint both groups of companies with the same brush.

By the time a startup gets to Series A, it should be well on its way to producing a finished product, finding a good market fit and developing sales. By Series B, it should be rapidly growing sales and/or preparing to scale.

With a seed company, however, it’s a bonus if it’s come close to nailing those down.

In any case, it’s best to have a portfolio of startups that are in at least two different phases of fundraising.

  1. Look for professional investor confirmation. Virtuix, one of the companies we’re recommending, is a good example. It makes virtual reality a more active and immersive experience by allowing users to walk, run and jump while staying in a small and confined space.

Mark Cuban invested here. So did other VC investors like Scout Ventures, Tekton Ventures, Western Technology Investment, Scentan Ventures, QueensBridge Venture Partners and 2020 Ventures.

When the pros like the same startups you do, it validates your interest.

What it doesn’t do is guarantee success. For that matter, a lack of professional investor participation doesn’t necessarily guarantee failure.

I would have recommended Virtuix regardless. But knowing that it also struck a chord with several savvy VC investors made me feel more certain that I was on the right path.

  1. Always look forward. Try to catch trends a little early as opposed to a little late. For example, 3-D printing, car sharing and food delivery are all incredibly hot sectors that have attracted gobs of venture capital in recent years.

But I’m not interested. The startups raising in these sectors now are – for the most part – me-too-ers.

On the other hand, the frontier technologies – virtual reality, augmented reality, artificial intelligence and robotics – will spawn dozens of hugely successful companies. And in healthcare, startups are just beginning to figure out where the big opportunities are.

Looking forward, this is where the most profitable action will be.

  1. Remember that, to win, you need to lose.

Much more so than in the stock market, early-stage investors tend to get attached to their positions.

It makes total sense. In many ways, startups are like puppies that are figuring things out and making their way in the world. And you’re watching them grow up, and get bigger and stronger.

There’s nothing wrong with any of this. But what happens if one of your startups goes under? It’s human to be disappointed.

Just be careful that you don’t overreact. It does NOT mean you made the wrong decision. It does NOT mean the startup betrayed you. And most of all, it does NOT mean the startup space is evil.

Do not panic. The sky is not falling down.

The fact is you will have failures. The most successful venture capital firms have more failures than successes.

Admittedly, this is much easier to accept when it’s your 25th startup investment that folds. If it’s your first, second or third… it’s a different story.

So you’ll want the founders to forge on. You’ll feel the need to do something to save them. Failure is hard to accept.

Yet it’s part of the startup investing process. It’s what you signed up for.

You need to steel yourself. Because failures are the price you pay for the thrill of landing really big winners – the kind that have virtually disappeared from the public markets.

Don’t give up before you’ve given early investing a chance.

Early Investing Is Different

 I started off this report by saying that equity crowdfunding is different from public sector investing. So let’s end it by reviewing why:

  • You’re investing much earlier in a company’s journey with much less track record to go by.
  • You’re investing in private shares. They’re not publically traded. And you can’t sell them until a cash event occurs like a buyout or IPO, which can take anywhere from two to 10 years. In the meantime, your shares are illiquid. Even if you’re sitting on a 10,000% profit, you can’t sell them.
    The huge silver lining to this? You’re forced to keep the shares, which means you could watch your profit climb to 20,000%. This is the very essence of long-term investing.
  • The risks are higher than what you’re used to. But the financial rewards can be enormous on companies that grow, scale and then IPO.
  • Information is often scarce. The technology can be cutting edge with untried, unproven solutions. Researching these companies isn’t easy, even if you have all the time in the world – which most people don’t.

This is where Adam, Vin and I come in, using our more than four decades of collective experience to evaluate the opportunities presented.

I hope you’ve acquired some tools to help you get started in this exciting new investment realm. But remember that, as you’re learning the ropes, you have our expertise to fall back on.

Good luck,

Andy