Invest in what you know

Black Swan - CSUF Entrepreneurship

As an investor myself, I can attest to how difficult it can be to stick to that advice in the title. As an investor, you get to see all kinds of ideas and meet with many different entrepreneurs. Many of them have very compelling stories, and we know that startup stories are important but there’s more to it than that for investors.

What do I look for in an investment?

This isn’t going to be an exhaustive list but here are the highlights:

  • Finances: All past and forecasted (three years ideally) income statements, balance sheets, and, probably most importantly for me, cash flow statements (it’s important for me to see this so I can get a better handle on what the startup’s burn rate – how much money it is spending each month – and runway – at the current burn rate, how long can the startup stay in business – are)
  • Customer Research: Knowing who your customers are is vitally important. I have seen too any startups that have products or services that they are trying to find customers for when it really should be the other way around. And the beauty of being focused on customers first is that you know they are there and are willing to pay for a solution to their problems. Your ultimate product may be some awesome system that will revolutionize the market but that doesn’t mean you can’t do anything unless you are able to launch at scale from the outset. Instead, create something that starts to solve your customers problem (i.e. a minimum viable product or, in the words of Paul Graham, do things that don’t scale) and you can build on that over time and with input from your customers.
  • IP: Intellectual property is important as well. Yes, current IP is important but a strategy for growing a startup’s IP portfolio is also very important.
  • Strategy: As an investor, I want to know how my money or the money I’m investing is spent. Does the startup’s strategy make sense? Have they really thought this through? Are they smartly allocating their resources? Every startup is different so there isn’t a simple way to assess strategies but, in general, you are first looking for a strategy that you are confident the founders have really thought through and then you are looking to see if you agree with their strategy.
  • Team: This is one of those categories that startups must excel at in order to get funding (or at least it should be). Having a team enables you to scale your company up because there’s no way that an individual or even just a couple of people in a garage can really scale any kind of business that is worth investing in. And the team has to have the right mix of people in terms of talent and temperament.

Invest in what you know

The firm that I am a part of has a great mixture of investors all with impressive backgrounds. If, for example, I don’t know very much about short range private plane travel and we are seeing a presentation from a startup that has an innovation that they think will revolutionize that industry and yield impressive results for their investors, I will focus on what I know when discussing the investment with the startup and with my fellow investors.

For me, I understand the startup process. Finances, marketing, and operations are all different in startups than they are in more mature companies. They have to be. My knowledge in these areas helps me make the determination of whether or not what the founders are saying makes sense and whether it’s a company worth investing in.

For industry specific knowledge, I will rely on the fellow investors in our firm. Without fail, at least one or two of them will have some specific knowledge of the industry we are discussing. They will at least know enough to make an informed opinion on whether or not the idea actually passes the smell test, or, in other words, if the startup’s solution is something that would be useful to customers. (And, yes, customer research will help in this area as well.)

It’s possible that I am more lax on this than other investors are but I think we can all agree that if you know nothing about a particular industry and the learning curve to get up to speed on that industry is too long then it’s best to pass on that investment.

Doing what you know isn’t always the best advice (it stunts growth, really) but, when it comes to investing yours or other peoples’ money you better stick to what you know. And if a hot new industry emerges onto the scene, there is no reason for you not to educate yourself on that industry.

Take as an example the CBD industry. Over the last couple of years there have been a lot of investors taking crash courses on everything related to CBD. Heck, I just got a message from the local Harvard MBA chapter promoting an event they are hosting on CBD. Investors all over the country are learning about this industry, all of its rules and regulations, who the big players are, what customers think about the various products, etc.

My point here is that if you don’t know anything about an industry then you should pass on making investments in that industry. But if that happens and you think that the rewards would potentially warrant it then you have an obligation to learn as much as you can about that industry so that when the next investment opportunity from that industry comes at you you will be ready to make an informed decision.

(Note: This post was inspired by a talk that Thomas Beckham gave at the CSUF Startup Incubator a few weeks ago. Thomas is a partner at Culver Partners and his talk was on how startups can successfully raise capital.)

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