Startup investors seem to get all the attention these days. Now with the expansion of crowdfunding platforms things seem to be tilting ever more in their favor. While the gulf between startup and stock investors seems wide there are things the two can learn from each other. In that light I asked Josh Maher the author of Startup Wealth: How the Best Angel Investors Make Money in Startups to address this issue. Below Josh talks about what lessons we can take away from how the best startup angels going about making money.
Learning from the best startup investors by Josh Maher
“I don’t know anything about investing in public markets” is a theme I hear a lot from startup investors. The claim is, early stage investing is so much more different than investing in public companies that early stage investors have no business investing in public companies. Not every angel or VC echoes these thoughts but many do. The sentiment rings true for public market investors as well and the resulting divide keeps some of the great learning about investing in the silos of the private and public spheres.
After interviewing over 50 of the best angel and startup investors in the world and publishing a best-selling book based on the interviews, I realized that this divide was artificial and there’s a wealth of things public market investors can learn from startup investors. Similarly, there’s a wealth of things startup investors can learn from public market investors.
Here’s an example, the simple concept that there are different types of successful investors is commonly understood and welcomed in public markets. From the slick momentum traders looking at volume and price, to the hermitic deep value investors, the opportunistic special situation investors, and on and on. Turning to startup investors, there are a number of different approaches (that easily align with their public market counterparts). Some investors are investing based on value – looking at how the management team has proven they can be successful creating value for customers and who can demonstrate an ability to grow that market share efficiently. Some investors are investing based on momentum – the pure speed at which they’re growing as measured by price (valuation) and volume (customer or investor interest). Sounds familiar doesn’t it?
So what can public market investors learn from startup investors?
There isn’t a lot of data available to analyze when looking at a startup so some of the best angel investors get really good at focusing on analyzing a few key areas for their qualitative and quantitative value such as funding pipeline, existing execution, and future assumptions. These sound fairly simple but let me explain. The funding pipeline for any startup falls within a more limited money supply, only so many deals can feasibly be done in a given year and this limit can affect companies who are growing but need more capital to fuel that growth and have also fallen below the cut. It’s not to say that the business isn’t a great business, it’s just to say that there were others that were growing faster or were more attractive at the time. Given more capital the business that missed out may have been just as successful as any of the others. Understanding how the management team thinks about capital, how the capitalization structure can impede or facilitate growth is the same no matter what the stage.
Looking at the capitalization structure is one clue to assessing management’s ability to grow a company at scale. Another is looking at the past execution as reflected by where the money and energy have been spent to date. What do those decisions tell you about the entrepreneur and management team? Many investors find entrepreneurs have learned from their mistakes, changing the way the business functions so that it’s best positioned for success. With a similar looking glass they’d find a lot of management teams sitting on their laurels refusing to position the company for growth because of some external influences.
Future assumptions are just as critical. Joanne Wilson is quoted in my book as saying, “‘Are these people or is this a person that I think has the ability to execute in scale?’ I think those are the two words that make a really good entrepreneur…”. First, are they making the right assumptions that support the anticipated growth. Second, when the company gets to that next inflection point and the one after that – will this team still be the right team to run that business and if they aren’t will they get out of the way so the business can thrive and grow?
“‘Are these people or is this a person that I think has the ability to execute in scale?’ I think those are the two words that make a really good entrepreneur…”. -Joanne Wilson
Management diligence isn’t the only area that’s interesting to learn from. Market dynamics and product innovation are a crucial component to any business, whether that business be young, old, growing, or stagnant. Evaluating the approach in which a company is taking their product to market tells an investor a lot about the team’s understanding of that market and the connection with the customers they’re adding value for. These key clues to execution risk would have easily saved an investor from investing in Ron Johnson’s JC Penney turn around.
Some angel investors have a preference to invest in trends. These investors just happen to know the other investors who are adding all that volume to the trade. They also have the possibility of riding much longer trends, especially given the slow market for IPOs. The downside of course is that they have no way to stop out of a trade so they have to be a little surer these are long term momentum plays. This focus on longer term trends forces early stage momentum investors to think more crisply about the world in which this trend continues for 5-10 years and that skill, that focus on investing in the biggest ideas that are showing a solid price and volume trend is one that public market investors can learn from. There’s no question investing in Apple or Amazon over the last few years was a great trend to ride. Deeply thinking about where the world is going and how the excitement around a stock will wax or wane depending on the answer helps in positioning to ride those longer trends and fads.
Quants? Well they are there… but early. That’s not to say there will never be anything to learn from quantitative startup investors. Some of the quantitative models out there focus on things like fundability which means methods for analyzing a limited data set for these nuanced signals is important and can have broader benefits in the public markets.
Josh Maher is the author of Startup Wealth: How the Best Angel Investors Make Money in Startups. Startup Wealth delivers engaging interviews with early-stage investors in Google, Invisalign, ZipCar, Uber, Twilio, Localytics, and other successful and not so successful companies. You can learn more about the book and get additional material on the Startup Wealth website.
He’s a passionate supporter of the Seattle startup community, President of Seattle Angel, a non-profit focused on education at the intersection of startups and angel investing. Seattle Angel launched the highly successful Seattle Angel Conference and recently launched the Seattle Angel Fund. Josh, an angel investor himself, has been consulting, mentoring, and advising startups since 2007 and has recently been working to help individuals with strategies for including early stage investments in their overall portfolio. If you are a family office or need the services of a family office, Josh has some interesting projects in the works to help you.