Maximizing the Cash-Out Potential of Your Startup Portfolio

Forget how you build, track and cash out your portfolio of public stocks.

A portfolio of startups is different. Very little from your stock investment experience applies.

In this report, I’ll be outlining a new set of portfolio management rules and tools that specifically apply to startup investments.

Let’s get started.

Building Your Portfolio

In putting together a startup portfolio, you need to remember these three things.

Ease into it. Sure, you’re excited. But you also have much to learn.

There’s an understanding in Silicon Valley that new venture capital hires spend their first two years making wildly inconsistent investment choices.

Expectations begin rising in the third year. Finally, enough progress has been made along the learning curve for these recent hires to start earning their keep.

And these are professional investors. They do this full time.

For a part-time “investor”? Even more patience is required. You need to take your time. No reason for you to invest in a dozen companies during your first two months.

Remember, once you invest in these companies, they’re yours for years. If you change your mind about a company, you’re stuck. You can’t sell your shares.

(Of course, you’re welcome to replace your experience with ours. So, in following our recommendations, you can move faster because your investments would be based on many years of experience.)

Invest according to a budget. You should have some idea of how much money you’ll be investing into startups.

As a general rule, it shouldn’t be more than 5% to 10% of your investable savings. How would that work in practice?

Let’s say you’ve saved $100,000.  You can put at least $10,000 of it into startups. And assuming you’ll be growing your savings over time, you can ultimately put in more.

You should invest in a bare minimum of 10 to 15 companies over that time. But I strongly suggest aiming for twice or even three times that.

The more, the better.

Let’s do some quick math here. I’m putting you on a five-year hypothetical plan. You have five years to build a full startup portfolio.

This means you have a budget of $2,000 a year. (The budget for the later years should be higher as you grow your savings, but let’s keep things simple and ignore that for now.)

The SEC allows everybody to invest at least $2,000 into startups each year. So you’re not going to get into trouble with the government.

Working backward, let’s say you’re aiming for a portfolio of 25 startups. Each year, you’ll need to average five startup investments. That comes to an average investment of $400 per startup.

That’s average. But what if you REALLY like a company?

This is where a budget comes into play.

If you invest $1,000 in this one startup, you have only $1,000 left to invest in the remaining four.

It’s not the end of the world. With $100 minimums available on many seed-round investments, it doesn’t have to be a budget-breaker.

But what if there’s another company that you’re really excited about?

Now you’re feeling a little hog-tied. Not a good feeling.

One way to avoid that is to keep most investments at the minimum. The really SPECIAL ones? You can double up and still remain under budget.

Much like what a spending budget does, an investment budget forces you to act with discipline, think ahead and not go too crazy.

But how about budgeting for beyond your first five years?

Remember, you will probably see some liquidity coming in the three to five years after you first start. And in years five through 10, your exits, along with your real profits, should pick up – boosting your savings and giving you the ability to reinvest in more startups.

Diversify your portfolio. Again, I’m not giving stock-picking advice here. But, diversification is important.

Sector diversification is pretty much a given. Chances are, even if you love, say, the drone or virtual reality sectors above all others, there simply aren’t enough of these startups available for you to populate your portfolio with companies only in these sectors.

Other ways to diversify? You can diversify by portal (sources for finding startups), fundraising round (seed, Series A, Series B, etc.), geographical location (U.S. city or country) and audience (consumer versus enterprise).

Here’s another one: having a combination of single startups and funds of startups in your portfolio.

I keep all of them in mind.

But the one thing I don’t do is prioritize diversification over quality. I do not invest in an enterprise company if there’s a better consumer startup available. I don’t select a company from SeedInvest.com if there’s a better one on MicroVentures.com. And so on.

But if I think I’m short on enterprise companies in my portfolio, I make doubly sure I pay attention to all the enterprise startups that become available – perhaps even spending an extra few minutes on them when I first come across their offerings.

At the end of the day, you should obey this one commandment above all others: Invest in the best and forget the rest.

Tracking Your Portfolio

This is optional. You can just invest and walk away, if you want. I have no problem with that. Unlike with public stocks, you don’t have to know when to sell in order to capture gains or prevent losses.

With startups, your shares are illiquid. You’ll own them for three to 10 years.

This is honest-to-goodness long-term investing.

Follow the journey. Personally, I want to know how my startups are doing.

I’m curious. Heck, maybe I can help them in some way. I know people who know people. I want to be part of the journey, even if it’s not always smooth.

So, if you want to keep up with a company’s latest achievements, you could sign up for updates (usually on the company’s website).

Or you could use owler.com to track any company you want. Or you could set up Google Alerts.

And, of course, we’ll give you updates on our companies based on our communications with the founders.

Follow the valuation. Even though I can’t cash out, I want to know if my investment returns are trending in the right direction.

If a startup is growing revenue by 300% a year, it’s likely that valuation is going up, for example. But you don’t know for sure or by how much exactly until the startup decides to raise money anew.

That could be anywhere from 10 months to two or three years away.

It’s just the way the market operates. Homeowners and first-time homebuyers should be familiar with this situation.

Houses aren’t liquid. (Just try getting cash for your house tomorrow.) Nor is their value obvious. You need to get together with a realtor… figure out how demand is trending… and what the comparables are… throw in interest rate considerations… and the new mall being built a couple of miles away…

Then come up with a valuation (or price) that you hope gets it right. But still, even at this point, you can’t be sure. You may find out that your house is worth more or less once you put it on the market.

It’s the same with startups: Paper profits are nice, but you won’t know for sure how much they’re worth until a liquidity event occurs.

A useful calculation to make is internal rate of return, which measures the increase in value. So, if a startup’s valuation grew 5X (or 400%) in three years (not unusual for the ones that “hit”), your internal rate of return is 70%.

That’s a hypothetical example, of course. As a general rule, your return should be at least 1.5 times as much as what public stocks are returning (to be worth the risk).

Cashing Out Your Portfolio

At some point, you’ll hear either very good news or very bad news.

You’re either about to put real greenbacks into your pocket via a buyout of your company or via an IPO… or you’re about to get the bad news.

The company is calling it quits. Or it’s getting chopped up and sold.

The specific liquidity event determines how you cash out, how much you make and what your choices are. There are three basic kinds…

Buyout. Could be good or bad news. Read the terms of the acquisition. You’ll get a letter from the company informing you that it’s been acquired.

Buyouts can give you life-changing gains. Or they can give you modest profits. They can also happen at any point – very early, very late or sometime in between. Historically, returns from buyouts haven’t been as big as those from IPOs, though this is beginning to change.

If the acquiring company is buying the company for its technical employees, the return definitely won’t be great. If it’s a fire sale, you’ll make a small profit at best.

Best scenario is to get cash in return for your private shares. But sometimes the buyout will be for shares of the acquiring company. Other times, it’s a stock and cash deal.

IPO. This is great news for early-stage investors: You’ve probably made 10X to 100X. (See my post “Should You Invest in Snapchat?” as to why this is so.)

The government imposes a six-month lockout period on pre-IPO investors. You can’t cash out during this period.

That’s not such a bad thing. It’ll give you a chance to sit back, take a deep breath and figure out whether you want to keep or sell your shares – which are now converted into public shares, by the way.

In 2016, roughly half of IPOs went down in price in the months after their public listings. Half went up. Most years, new public companies do better, but some years, they do worse.

I think that capturing huge gains is never a bad move.

But for the more adventurous, keeping a third to half of these shares beyond IPO day to reap even larger possible gains could make sense. It’s a very personal decision. I can’t make it for you.

That said, whenever our holdings do IPO, we plan to give you the pros and cons of both keeping shares and cashing out.

When it comes down to it, that’s not a bad problem to have.

Bankruptcy. It happens to the portfolio holdings of the best (and wealthiest) investors. And it’ll happen to you.

Some startups just don’t make it. As they unwind their assets, you may get something back. It probably won’t be much. Take the money and move on.

In summary, I hope this report provides you with a blueprint for establishing, managing and profiting from your startup portfolio.

Startup investing is a fast-growing sector of the financial industry that is virtually certain to continue growing in the months and years ahead.

With the right approach and mindset, I think you’ll find it to be a very lucrative addition to your asset management strategy.