Being an early stage investor is now a status symbol. For individuals, funds and companies. Unfortunately, not everyone should be an early stage investor focused on the seed stage. What are the key considerations?
How much time do you really have?
This is the first question for everyone, from small angel investors all the way up to large corporates. No matter how much money you have, your main constraint is actually time. The most common feedback from people who have just started to invest in early stage companies is that the time commitment was beyond their expectations.
Every single investment made takes significant time, both in terms of due diligence before the investment and, more importantly, support after the investment. To build up a successful early stage portfolio, diversification helps because of power laws and so at least 15 investments but probably closer to 30 is the right size. In addition, to even find a single investment, most investors should first look at 100 potential companies. When you multiply the time commitment through that funnel, it suddenly starts to look like a full time job for one or more people.
Where is your geography?
The traditional approach to geography in early stage investing is hyperlocal. The upside of this philosophy is the close contact with the founding team. The downside of this philosophy is that your universe of opportunities has been reduced significantly and you probably lose the broader perspective of what is happening in other markets. In today’s world, not having a global perspective is a competitive disadvantage.
Some investors, including ourselves, take a cross-border approach. While this provides a significantly larger universe of opportunities and a more diverse perspective, it is extremely difficult for most people to execute in practice. You need a team that is comfortable across both physical distance and cultural nuance. Most early stage investors are actually better off partnering with someone who knows how to do this rather than trying to replicate this skill set in house because it is not easy.
Who is your network?
Clearly the quality of your network will be a key driver of both your investment opportunities and the value you can provide after investment. In the past, having a network of strong connections to people in high places was the ideal. Access by itself was a key asset. As the cost of building an early stage startup has collapsed, the doors for everyone else have opened up. Knowing people in power will always be valuable, but it is not the most important feature of a network anymore.
Instead, the ideal network is diverse and connects small worlds with loose ties. This means spending time with different kinds of people across demographics and skill sets. Unfortunately, most investors are simply not experienced with diversity. If you do not have a diverse network, find someone who does and partner with them.
What is your value add beyond money?
Ultimately, money by itself is a commodity. At the early stage especially, where the capital requirements are smaller, having more money is not by itself a competitive advantage. In fact, the pressure of having large amounts of money to invest is actually counterproductive at the early stage.
Therefore, all early stage investors need to bring additional value beyond money. As discussed above, network diversity is a key point of differentiation. Domain expertise is another helpful factor and is fantastic when it works well. The challenge with domain expertise is ensuring that the investor is not trying to be an operator and run the business for the entrepreneur. It is important to ensure that investors understand the reality of what hands-on vs. hands-off really means. Ultimately, most investor value add is useful when it is complementary to the skills of the founding team, filling a gap. By definition, this is unique for each company.
Why are you investing?
If your motivation is to find a status hobby, you will be in for an expensive lesson. When it comes to hobbies, collecting classic cars would be cheaper and cooler. While this goes for individuals, the same logic applies for more sophisticated investors. Family offices who want to dabble in angel investing because of the fun factor may be attracted by the hype but ultimately will find it both less profitable and less enjoyable than expected. Even corporate investors, who have jumped in aggressively into venture capital, need to have a clear strategy. In all the cases, from individual angels through to the largest companies, it is important to have a deeper motivation than simply because of the excitement.
Some people invest simply to learn while of course many also want to make money. In both cases, you may actually be better off by investing in a fund or syndicate because having a more experienced investor will most likely result in stronger learning and higher returns as compared to simply making your own basic mistakes. The data shows that early stage investors fall into two categories: those who know what they are doing and those who don’t.
There is no question that we need more early stage investors. But before jumping in, ask yourself the above questions. If the answers still convince you to jump in, then go for it. If the answers create some hesitation, then find more experienced investors and partner with them so that you can still get the benefits without creating new headaches for yourself.