How to Make Money Investing In Startups

When I was working in Silicon Valley in the 90’s, every snot-nosed new grad wanted to make money working for a startup and then become an angel investor. Some of them were investing $1000 or $2000 into companies their friends were starting, just so they could say, “Yeah, I do a little angel investing on the side.”

It rubbed off on me, and when I first made a little money I could invest, I would go to networking events and say to people “Hey, I have a little money to invest, do you have any ideas?”

As a way of finding deals to invest in, it actually wasn’t terrible. There are two types of startup investment opportunities you’re going to run across. The first is a company being started by someone you know or someone you discover. These opportunities are going to mostly (overwhelmingly) suck, but at least you’re not competing with anyone else to invest.

The second is getting a pitch from an entrepreneur who is actively fundraising. They could reach out to you because they know you or because they’ve heard of you. They could present to an angel investing club, there are one or more in every major city. Angel clubs get hundreds of applications from startups, and filter down to a few that present at a monthly meeting. Sounds like some great curated deal flow right?

Fuck no.

The beginning of my real education as an investor came at a wedding reception. The groom was a friend entering the venture capital industry, after graduating from Harvard Business School. There were several VCs in attendance and I happened to be sitting between two of them at dinner. With a little swagger in my voice I mentioned, “Yeah, I do a little angel investing on the side.”

The VC on my right, Frank, smirked, and said, “Angel investors are just cannon fodder for venture capitalists.” The VC on my left looked away. I think I heard him snort.

I asked Frank what he meant and he told me that VCs are constantly scanning for deals and taking meetings with nearly anyone who has a credible idea. The best VCs don’t have to do as much scanning because they get called in on great opportunities by their friends. Frank said, “We see everything you see. If they make it to you, it means we said no.”

No entrepreneur is going to take money from an angel when she could have taken money from a VC who can provide them with expertise and access to more capital.

Which brings me to the two words that will determine how successful you are as an investor.

Deal. Flow.

You have to be in a position to see the best deals, the Glengarry Deals. And what makes a great deal? It’s not having a great team, or a charismatic founder, or a great idea, or a massive market, although all of these can help.

Here are a few characteristics of the best deals:

1. You have to beg the founder to take your money.

2. They have a Tier 1 VC already investing, or access to downstream capital.

3. They came out of one of the top accelerators. Techstars, 500 Startups, and Y-Combinator are three I’ve invested with, but there are many more.

At the time of my conversation with Frank, I was a member of an angel investing club, had about a dozen investments, and all of them looked like garbage by these standards. Over the subsequent years, not a single one has paid off in any meaningful way.

I’ve invested in 80 startups over the past 20 years, tracking things like what convinced me to make the investment, what I thought of the founders, and how sure I was that it was going to succeed. What I’ve learned in that time, is… I know nothing. Is winter coming? I have no idea.

But I have great deal flow.

Out of those 80 investments I’ve had six massive wins. Huge. Extraordinary. Life-changing. Also 20 abject failures, another 10 underachievers, about 10 so-so wins, and 35 or so where the jury is still arguing. And I could not have predicted a single one of the outcomes.

I invested $2 million in Field Trip, a startup that IPO’d and later went bankrupt, I barely got my investment out.

After a Y-Combinator demo day I invested $50k each in three companies, and then saw two more I liked but had only $50k more left to invest, so I split it between them. That’s how I ended up investing $25k in RazorPay, a boring little startup that was going to solve credit card processing unreliability in India. Every year after making that investment, they would email me and ask if I was willing to sell my share, and the number kept going up. I finally gave in after four years and sold for $800,000.

If I’d hung on until today, they’re planning an IPO and my shares would have been worth about $5 million. On $25k. Imagine if I’d invested $50k. Or my current standard $100k. I could have been somebody.

I invested $150,000 in Mejuri, an online jewelry company that was graduating from the 500 Startups accelerator. I invested because the head of the accelerator told me Noura Sakkijha was the best CEO in the entire class. And because Noura and her husband Majid agreed to come on a party bus with me and a bunch of Silicon Valley friends, proving she was my kind of people. I’ve since given up on that kind of test, but we had fun, right Noura?

Noura is an awesome CEO. Mejuri has gone up 400x since I invested. I’ve been diluted down to a small fraction of my original ownership share, but it’s still been a hell of an investment.

Deal Flow.

The lesson is that you can’t predict the winners and losers, but as long as you diversify, and you have good deal flow, and invest the same amount every time, you’ll outperform any reasonable benchmark. My return over the past 20 years has been over 40% annually, compounded. And I did a lot of dumb shit as I learned along the way.

Deal Flow. Invest the same amount every time. Diversify.

My most consistent successes have come from investing in graduates from tech accelerators. It just takes a little maneuvering to get invitations to their demo day events where they pitch investors, and if you maneuver a little more you can even meet them before they pitch a larger group of investors, which is when you can get the best valuations.

Then once you’re seeing quality deal flow, you still have to decide which companies to invest in. How to decide?

1. Invest in projects you like that are doing something meaningful to you, because then if it doesn’t make money, at least you did something good for the world.

2. Co-invest with people who know what they’re doing. If they already have a good VC backing them, you’ll have to elbow your way in to get them to accept your money.

3. Invest in industries where you know the competitive landscape and you know whether a new product is doing something needed and something novel.

So if you’ve got a little money to invest and tech startups fascinate you, start networking. Figure out how to get invited to demo days. Meet successful VCs and successful angel investors who have consistently made money. You think great investors like Naval Ravikant, Jason Calacanis, or Mark Cuban can sniff out a quality deal better than you can? Bullshit. They know people and they get access to the best deals. Period.

That’s not to say you shouldn’t have a little knowledge about private investing. Read up on vocabulary, know what a SAFE is, ask for cap tables, know that you should laugh when an entrepreneur is raising on an uncapped note. But mostly, network, network, network, and get access to the best deal flow. Don’t be cannon fodder. Be the guy or gal running behind the cannon, picking up scraps of plunder. What do they call them? Oh yeah.

Rich.