A Word on Startup Investing

Taking asymmetric risks on people building new things is fun and scary

Three years ago, I hosted one of my Toasts dinner parties with “risk” as the theme. Despite choosing this theme, I felt like I had nothing much to toast to, that I lived a fairly risk-free life. Given my entrepreneurial background, people often assume I’m a natural risk-taker. In reality, I think most entrepreneurs are experts at managing risk, not chasing it.

Around the same time, I read Paul Graham’s advice about investing:

"Take as much risk as you can afford. In an efficient market, risk is proportionate to reward, so don't look for certainty, but for a bet with high expected value. If you're not failing occasionally, you're probably being too conservative."

So, thanks to PG and a dinner party, I decided to take some risks and jump back into early-stage¹ investing. I had some solid early wins with Vend in 2013 and Publons in 2014—both of which paid back 7-8x my original investment—but then took a long break, so this was a good kick in the butt. We sold a chunk of our business to a private equity firm in 2021 so I decided to set aside $1 million for early-stage investing, planning to make about 10 investments (bets!) of $50K–$150K each².

These bets might seem risky (they are!), but what PG is saying above is that the risk is asymmetrical. The downside is capped at the amount you invest, but the potential upside is enormous. With apologies to Michael Simmons, in cricket when you swing, no matter how well you connect with the ball, the most runs you can get is a six³. In startup investing, every once in a while you can score 1,000 runs. For example, if I’d held onto the Xero shares I bought at $1 during its IPO, I would’ve seen a 197x return. (Instead, I sold at $4.50, thinking I was a genius.)

You do need to have a strong stomach though, for two reasons.

First, most of these investments fail. Correlation Ventures analysed over 21,000 venture financings and found that 65% lost money, 2.5% returned 10x to 20x, and just 1% made more than 20x. Half a percent—about 100 companies out of the 21,000—earned 50x or more, driving the majority of the industry’s returns. That’s why it makes sense to have a diverse portfolio.

The second challenge is the time frames involved. A successful investment can take 15+ years to bear fruit, while the ones that fail tend to fail fast. As the saying goes, “lemons ripen before apples.”

And just because you’ve seen success as an entrepreneur does not ensure success as an investor. I’ve made a dozen early-stage investments and have made a bunch of mistakes:

• Assuming a business was a good investment simply because it received backing from a well-known VC, thinking “the VC must have done the due diligence.”

• Investing in (several) pre-traction startups—with no revenue and sometimes no product. It is an unnecessary risk, and what Jason Calacanis calls “the cardinal mistake of new angel investors.”

• Accidentally becoming the sole investor in a company because I didn’t ask the right questions about who else was participating.

• Putting too much money into a small number of ventures instead of spreading my risk. As I mentioned, I was targeting investments of around $50K–$150K. My thinking was that the initial investment needed to be substantial enough to make the returns worthwhile. However, as I’ve learned, most early-stage investors start small, buying a $5K-$20K “ticket to the game,” and doubling down on winners later. Ironically, this might work out for me—I may have accidentally put “too much” money into winners when they had a low valuation—but if that happens, it’ll be pure luck, not a smart strategy.

• Investing in FMCG businesses without truly understanding their market and business model. Consumer businesses require a huge amount of capital to break through, and I underestimated that. Twice.

• Given the risks, most people limit their investments in privately held companies to 5–25% of their total wealth. If you include my residual shareholding in Optimal Workshop, I’m closer to 55%. Oops.

Despite these mistakes, I love investing in early-stage startups. It allows me to live vicariously through the founders while helping them bring something new into the world. It’s more rewarding to back them than to add to the trillions of dollars the world already has invested in bonds, cash, stocks, and real estate that sits there, growing slowly and safely, not making much impact.

If you do decide to invest in startups, and this is NOT INVESTMENT ADVICE, then Icehouse Ventures has a great series of webinars that I highly recommend. I also found Angel: How to Invest in Technology Startups-Timeless Advice from an Angel Investor Who Turned $100,000 Into $100,000,000 a useful read (if you can get past the bombastic language).

If startup investing is a rollercoaster, you might as well enjoy it

P.S. I’m going to do an Ask Me Anything in a couple of weeks. Do you have any burning, unanswered questions about anything that you’ve read in any of my posts? Let me know by replying to this email.

1. Ugh, just don’t call it angel investing 🤢. Investors aren’t saviours and don’t have halos, they are just people making educated bets and hoping for the best.

2. I was pretty 50:50 about sharing actual numbers here. Part of me thinks it’s a bit crass and worries about having this stuff on the public Internet, and part of me thinks that it’s the very detail that makes this stuff interesting.

3. The actual record for most runs off a single ball in first-class cricket is 286, set in 1894 in Australia, when the fielders lost the ball and the batsmen just kept running until it was found. 🏏