Mailbag: Learn From Venture Capital Investors’ Mistakes

Q: Do you think venture capitalists will learn anything from the WeWork debacle?

A: Great question. When you see billions of dollars in expected gains go up in smoke, it should leave a strong impression, as in…

I’ll never do that again.

But what exactly is “that” referring to?

  • Investing in a company losing money hand over fist? That would mean dropping 90% of the companies venture capital (VC) firms invest in.
  • Encouraging hypergrowth? That would be an extremely hard habit for VC firms to break. Pre-IPO, it’s all about growing fast (and breaking things).
  • Investing in companies headed by founders who are self-entitled pricks? Not if you thought that person was your meal ticket to making a killing.

Okay, let’s go less ambitious here. How about taking a closer – and, dare I say, more serious – look at a startup’s financials and growth strategy? All of this information was available to investing venture capitalists.

Seems reasonable until I’m reminded of Theranos. The best VC firms sunk $1.4 billion into the company for what turned out to be fake technology. Should they have known better? Of course. Just like with WeWork, they skimped on their homework… fell in love with the company and its massive disruptive potential… and cluelessly joined the crowd of A-list VC firms that were major investors.

At the time, I thought, well, here’s a lesson that won’t soon be forgotten. Theranos’ last raise was two days before Christmas in 2017. The timing was fitting. In the holiday spirit, Fortress Investment Group and other investors gave the company $100 million in investments. And this was after many of its improprieties came to light. Theranos could access the full amount only on the condition that it met certain milestones. It failed to do so. By June 2018, Theranos founder Elizabeth Holmes – fighting criminal charges – was forced to step down as CEO. In September, the disgraced startup sent an email to investors that it would cease operations.

Why go into Theranos’ story? Because it should have taught VC firms a lesson they’d never forget: DO YOUR HOMEWORK. Or else risk being victimized by an unscrupulous founder.

Yet here we are, a mere two years later, and VC firms have blundered their way into a pickle. They’ve poured $1 billion into a company that stands to lose huge amounts of money over the next year or two… if it survives that long.

VC firms may have learned a lesson. But will it stick? I seriously doubt it.

+ Andy Gordon, Co-Founder, Early Investing

Q: Any tips for a new startup investor?

A: Start slow. Online startup investing allows you to invest just $50 to $100 in many deals. Take advantage of it.

Take notes when you make investments. In your notes, explain why you invested in that startup and what you liked about the deal. Review these notes periodically.

Track your investments over time. Subscribe to the startup’s newsletter, if it has one. Follow it on social media. Use services like Google Alerts to be notified when the company is in the news.

Invest in companies with impressive growth. It’s the most important factor. Deals with great growth/traction may be hard to find, but they’re usually worth it when you do.

Back founders who have invested a lot of their own money and time into the business. The more “skin in the game” they have – and the more they’ve gotten done without outside money – the better.

Set a goal of investing in at least 20 startups over a few years. This will give you a good chance of hitting a big winner.

Lastly, don’t invest money you can’t afford to lose. Startups take time to mature and are high risk. That said, startups are a crucial part of a healthy and diverse portfolio. So we recommend investors dedicate a small portion of their portfolios to startups – usually no more than 10%.

+ Adam Sharp, Co-Founder, Early Investing