The paperback book came flying at me like a drunk bird.
It hit my chest and dropped to my lap.
“Read it,” said the short-tempered money manager (and book-thrower) who’d been interviewing me for a job on Wall Street. “Then we’ll talk.”
So I read the book.
And a few days later, with an inspired mind and a bruised chest, I marched back into his office and clinched the job.
Fast-forward Ten Years
Yesterday evening, when my Kindle was busy charging, I came across that old paperback on my bookshelf.
I don’t work on Wall Street anymore — now I’m an entrepreneur and investor in the private markets — but as I sat down and browsed through the book, I realized that its lessons are just as valuable today as they were back when I first read it.
The book I’m talking about is Peter Lynch’s Beat the Street.
29% a Year for 13 Years
Peter Lynch is the legendary money manager who ran Fidelity’s Magellan Fund from 1977 until he retired in 1990.
When he started managing the fund, it had $18 million in assets.
When he retired, it had over $14 billion.
His 29% annual returns make him one of the most successful money managers of all time.
Peter’s Principles and Startup Investing
In addition to stacking up a very impressive investment track record, Peter penned brilliant books on the topic of investing.
When Peter was writing, individual investors like you still couldn’t invest in startups, but his solid wisdom can be easily applied to any market.
For example, I chuckled when I read this line from Beat the Street: “Long shots almost always miss the mark.”
Investing in early-stage businesses seeking to change the world is essentially taking a series of long shots — which is why we’re always screaming at the top of our lungs about the importance of a rigorous investment process, and about diversification.
Here are a few of Peter’s Principles that are applicable to startup investing.
When you’re considering making an early-stage investment, use them!
Principle #1: “Never invest in any idea you cannot illustrate with a crayon”
If you’re thinking about investing in an early stage technology start-up — a company that, by its very nature, is trying to change the world — Peter’s advice on this topic might sound counterintuitive.
After all, aren’t these companies trying to tackle mind-numbingly complex technical challenges? Sure, some of them are…
But you should still be able to answer basic questions about them! For example:
- What problem are they trying to solve?
- Who is their target market?
- Does their product actually meet the needs of their target market?
- How do they make money?
Pretty basic, right? Regardless of how complex a business might be technically, the answers to these questions should be obvious.
Take Google as an example…
Google built a sophisticated search engine. I can’t even begin to understand how its algorithms work. But the basic problem it was trying to solve as a young company — allowing people to find the exact content they were looking for — helped it attract an extremely large audience.
Eventually it started placing relevant advertisements next to that content — and today, Google has about $140 billion in annual revenues.
If someone gave you a purple crayon and a napkin, you could draw Google’s business model in 60 seconds. That’s the sort of business you should invest in, whether it’s a public company, or an early-stage startup.
Principle #2: "The extravagance of any corporate office is directly proportional to management's reluctance toward shareholders"
I remember the first time I saw Google’s “campus” in California. I forgot it was an office — it looked more like a high-end spa. There was free gourmet food in the cafeteria, free daycare and dry-cleaning, free back massages, etc.
But it took it YEARS, and billions in profit, to get to that point. The founders started out in a garage and a dorm room, eating Ramen noodles and building their product — and that’s a good thing.
Founders of a start-up shouldn’t be focusing on luxuries; they should be focusing on growing their company and making sure they have enough cash in the bank to live another day. If they’re spending their money on fancy office space in an expensive building, take your hand off your checkbook!
So look for any clues that the founders are overspending on the wrong things — office space, big salaries, expensive company outings, etc. Those are red flags!
Principle #3: “If you like the store, you’ll love the stock”
Peter Lynch was adamant that individual investors could outperform “professional” money managers. All they had to do, he said, was to buy the stock of companies they knew, liked, and were customers of.
His logic was that customers perceived important insights into brands and products that simply couldn’t be detected by an analyst sitting in a big office reading financial statements.
The same theory applies to early-stage investing. As one professional venture capitalist told me, “If I can’t imagine myself using the product, I won’t invest.” His one exception? If his kids are in love with the product.
Lynch was the same way. As legend has it, he would send his teenage daughter to the mall with some spending money. After seeing which stores she bought from, he’d start his due diligence on those companies and analyze their stocks.
So as you start looking into early-stage investing opportunities, stop and ask yourself, “Would I use this product? Would my kids or my neighbors use it?”
More to Be Learned
If you liked the Peter Principles and are looking for other ways to be smart about investing in startups, check out our Resources page, and download our free 10 Commandments of Startup Investing Report »
Also be sure to check out our free “Tips from the Pros” whitepaper, where we interview five of New York’s top venture capitalists to discover how they approach startup investing.
You’ll find it on the same page.