Welcome back!
In my last article, I looked at the three key questions you need to answer before you begin investing in startups.
Now we’re ready for the next step, and this is where things get interesting:
You see, now you need to determine which startups to invest in. And spoiler alert — there are literally millions to choose from.
To start learning how to stack the odds in your favor, read on…
50 Million Startups a Year
Choosing the right startups to invest in can be daunting.
Roughly 50 million companies get launched every year. But very few will become successful. In fact, within five years, close to half will fail.
These statistics aren’t meant to discourage you. Instead, they’re meant to show you how important it is to invest in the right kind of startups.
Let me explain.
Why Do Startups Fail?
CB Insights, a prominent research firm that focuses on the private markets, recently undertook a detailed study. It was aiming to answer a puzzling question:
Why do startups fail?
In the end, it identified several factors — from creating a useless product, to failing to market effectively. But one factor was bigger and more important than all the rest:
The startup runs out of money!
Since then, this finding has been echoed time and again in similar studies, whether from the Small Business Administration or Harvard Business School.
For investors like us, this information is incredibly valuable:
If running out of money is the fundamental reason a startup fails, we need to avoid investing in the startups that are most likely to run out of money.
But how do we identify such startups?
Three “Identifiers” To Look For (And Avoid)
Identifier No. 1: Capital Efficient
For starters, look for companies that are “capital efficient.”
If a company is capital efficient, that means it can achieve significant growth with little investment. Such companies often have low fixed costs, so they can grow their revenues without a proportional increase in costs.
Such startups might include software or app companies.
Conversely, if a startup has high fixed costs, it will need more investment. That means it will be at greater risk of running out of money — and greater risk of going out of business, Such startups include companies building physical products like satellites, machinery, and electronics.
Certainly, not all hardware companies are doomed. But statistically speaking, their high costs correlate to a higher risk of going out of business.
Bottom line: all else being equal, stick to businesses that are capital efficient.
Identifier No. 2: Multiple Founders
Lone-wolf entrepreneurs like Mark Zuckerberg make for great headlines. But they rarely make for good startups to invest in.
According to multiple studies, startups with multiple founders tend to be more successful. Co-founders give you someone to strategize with, to share work with, and ideally, someone with different skills.
One study showed that companies founded by two or more people grew nearly four times faster than companies with solo founders. Makes sense. Multiple founders can get more done more quickly — and thus, they have a better chance at staying alive.
Identifier No. 3: Go With the Pros
In sports, those who get paid to play are called professionals — the “pros.”
It’s similar with startup investing. Here, the pros are called venture capitalists, or “VCs.” Their job is to identify and invest in promising startups.
The VCs who invested early in home runs like Airbnb, Facebook, and Uber — back when these companies were tiny startups — have earned reputations for having the “Midas touch.”
So if you find a startup that’s backed by a name-brand VC, you can feel good about following them into their new deal.
Furthermore, if a startup raises part of an early funding round from a VC (as opposed to exclusively from individual investors), it’s 63% more likely to raise additional funding later. That’s important. A well-funded startup has a better chance at staying in business longer — and having more runway can be a key part of figuring things out, and ultimately becoming successful.
Stay Tuned for Specifics
The three identifiers you learned about today can help you pinpoint startups that are more likely to stay in business — and thus, more likely to deliver profits.
Now stay tuned for my next article, where I’ll show you examples of specific startups that feature these key identifiers.
Until next time…
Best Regards,
Editor
Crowdability.com
