Script How to invest in startups

Hi everybody, my name is Igor Shoifot. I'm a founder at The Garage Syndicate and the partner at The Garage Syndicate.
We are an angel community of hundreds of angels that invested about $15 million in more than 20 startups in the last couple of years.
But as a venture capitalist, I also invested in about 100 startups and as an angel, I'm a shareholder in over 100 angel deals.
So altogether, there are a couple of hundred deals under my belt.
And today's lecture is going to be answering really just one simple question.
How can you make money by investing in startups?
The very simple answer to that is invest in fast growing startups at reasonable prices and very probably within a few years they will exit and will generate really nice multiples.
Hopefully you will make 5 times your money, 10 times your money, 50 times your money, the more the merrier.
What are the tricks? What are the simple rules of thumb?
So to say for somebody investing, somebody starting to invest or somebody who has been investing for a while, what are the rules to follow in order to increase the probability of success?
Well, there are several. One and the most important rule is only trust numbers.
Do not trust anything but actual real numbers, real numbers of sales, real numbers of monthly sales, monthly expenses, customer acquisition costs, lifetime value of customers, etc.
All the numbers that startups love to talk about, and I certainly don't blame them because they're dreamers, are how big they are going to be in a year, in 3 years, in 5 years, in 20 years.
Few of us have 20 years to spare to just put money somewhere and say, oh, I'll come back to this in 20 years.
I wouldn't worry. Really what you want is, first of all, to invest in startups that are not too early.
If a startup is just starting, really the startup should go to an accelerator, an incubator, learn how to grow, generate revenues, build the team, gather the very first money, get to the first revenues, scale, etc.
This startup, a startup at an early stage, is a very risky enterprise.
I'm sure you all have heard this funny statistical numbers, about 99% of restaurants closing.
If you dig a little bit deeper, you would learn that a huge majority of those are restaurants that close before they open.
The same is very true about startups. A huge majority of startups fail not at late stages, but at very early stages.
They fail to create a product, they fail to achieve a market feat, they fail to gather enough customers, to gather enough traction, they run out of money, etc.
Investing very early is tricky, but startups at the earliest, I would say, are the most available startups.
Any startup that is just starting, well, with the exception of startups that are started by some super stars, some X, senior VPs at Google or Facebook or Sun Microsystems.
Pretty much any startup would love to get funding, and it's very easy for startups to identify the so-called FFF, friends, family and fools.
Unfortunately, mostly fools get the money and start running using other people's money.
The trick for you is not to invest too early, but to invest at a stage when a startup is not as risky, when the business is already at least somewhat proven, when the customer acquisition costs, when the lifetime value, when the growth, all these numbers have been achieved,
and you could talk to the founders not about some prospects, not about some plans, not about some dreams, and again, we should not blame startups for being dreamers, but you should talk about numbers, numbers, numbers, and one more time numbers.
So rule number one, do not invest too early, rule number two, only invest in numbers. Make sure that whenever you talk to a founder, whenever you talk to a startup, you focus mostly on their proven, that's the key word, proven, ability to grow.
If a startup has not proven that it can grow, if a startup has not demonstrated a great or at least good, better great market fit, then chances are pretty high that this will never be achieved.
Another problem is that some startups actually create fantastic products, really great products, have really nice founders, address really huge painful problems, have great total addressable market, I'm sure everybody heard the term TAM or TAM, total addressable market, but do not grow fast, because they do not have what I lovingly call the gross DNA.
You either have a gross DNA or you do not have a gross DNA, and if you do not have it, chances are extremely high, you would not be able to grow fast.
And with a few exceptions, mostly in high-tech or pharmaceuticals, with very, very few exceptions, a company that cannot grow, a company that cannot grow fast, does not have really good chances for an exit.
And if a startup does not have really good chances for an exit, you as an investor would not have very good chances for high return on investment.
And rule number three, all you want is a reasonably fast and unreasonably high return on your investment.
If you are an investor and you are in investing just for fun, I mean nothing's wrong with having fun, right? But if you are in it just for fun, you're definitely going to lose money, I guarantee you.
Why? Well, because you're not going to care much about numbers, you're not going to care much about doing due diligence, you're not going to care much about how the startup in question, how A startup in question will be scaling, but rather you would be thinking,
Oh, such a great idea, oh, such great guys, I really need to help them. They're just awesome, you know, let's invest for just a sheer reason of a company being awesome.
This is a very wrong reason to invest, you could definitely, you know, waste your money, all you want, it's your money.
But if you want to make money, the most important goal that you have, the super goal that you have, is to keep your eyes on the price.
And the price that you have and the price, that would be a nice, for example, keep your eyes on the price and keep your eyes on the price.
The price is a great exit where you generate at a nice multiple, hopefully 10 times, 50 times, 100 times, 1000 times if you're so lucky and so smart.
But price, and that's question number four or rule number four. Price is very important.
If you keep investing in startups at unreasonably high multiples, then may I remind you a very simple thing.
Cambridge Associates, which is a very reputable firm, you could or should rather, Google that compiles annual lists of what are the typical so-called TVPI, which are the returns to investors after all the fees in a fund.
So according to Cambridge Associates, a good, a great typical VC return is 3x, so in other words, you put a million and you get back 3 million.
Not bad at all. I'm happy to put my money into something that on average, not if you're lucky, but on average will bring me 3x, if I'm lucky, maybe 10x, 20x.
But the problem there is that if you invest at valuations 2, 3 times higher than typical valuations, on average, you're not going to get anything, right?
Because you're looking on average again. If you're lucky, it might be 100 times.
But on average, you're just looking to make 3 times. Of course, the garage is not average, we hope to make it 10 times, 20 times, 30 times your money.
But let's be reasonable. Within just a few years, on average, without great luck, etc., you're looking to make 3 times, maybe 4, maybe 5 times, would you invest?
If you invest at 3 times higher valuations than the ongoing rates, then you're shooting yourself in the food. So do not invest at very high valuations.
A very important next rule is always do your due diligence. Always request the numbers. Never invest with your eyes wide shot, right?
Only invest in companies that are open to showing you numbers. Only invest in companies where you see the monthly dynamics, where you see the customer acquisition costs, where you can get very straightforward, clear answers as to how the customers were acquired, through which channels.
What are the LTVs, lifetime values of specific cohorts, etc., etc. In other words, if you want to invest as a smart investor, you need to operate with numbers.
If you do not want to invest as a smart investor, which is fine, then you don't need the numbers. You can just operate with these guys.
The product is great, the market is large, the chances are very high, you're going to fail. You're not going to return even 1x, so you're not going to make any money, and you're going to lose a lot of your money.
Unless, of course, you're lucky, but it would be a silly enterprise to invest just hoping that you're luckier than other people.
Everybody, of course, wants to win in a lottery, but investing all your money or significant amounts of your money into a lottery, as any financial advisor would tell you, is not the smartest enterprise.
The next rule, of course, and a very, very significant part of being a successful investor is deal flow. If throughout a year, I don't care if you're a VC or an angel, if throughout a year you see 10, 20, 30 companies, and that's all you invest in, you're going to fail.
If throughout the year you see a lot of companies, and you choose only several out of those, chances are much, much higher than you will succeed. Why?
Several reasons.
Number one, there is a steep learning curve, and pretty much whatever you would do, hockey, golfing, boxing, fitness, cooking, etc., there are always learning curves.
You can't just, even if you're a genius, you can't never have, never having played tennis, you can't just go to a court and immediately start playing like you're a Wimbledon participant.
The same is true about investing. You really need to listen to a lot of startups, you really need to read a lot of presentations, you really need to look into a lot of P&L profit and loss statements, you really need to go through a lot of work.
You need to go through a lot of pitches, a lot of discussions, a lot of meetings with other investors and with startups, and only after that you're going to get not just intuition, intuition is important, but it's not something primary.
You are going to get an understanding, some sort of mastery of how to deal with startups, how to invest in startups, and the more you focus on specific verticals, for example, on software as a service, on e-commerce, on medical services, etc., the more you would start to understand that segment.
So, you need to see a lot of deals. That's number one and that's why great deal flow is important.
Number two, sometimes you see a deal and you like the deal and you pay less attention to what here in Silicon Valley is known as hair in the deal.
In other words, you get a great drink and all of a sudden you see bartenders hair, or maybe not bartenders, maybe some one of your friends hair floating in your lovely drink.
The same could be true about startups and sometimes there is, as again we say here in California, a lot of hair in the deal. So, if you only saw several deals and you like them and not very significant growth, very high burn rate, too high of a valuation.
That's all hair in the deal, hair in the deal, hair in the deal, screaming at you, look, here is a lovely lock of hair floating, are you going to drink me?
The best suggestion is don't drink it, don't drink the Kool-Aid, don't drink, don't do the deals with hair in the deals, but if you have a lot of different deals you're looking at, if you have a great deal flows, you can afford to say no to reason or not.
You can't afford to reasonably good deals, but not good enough deals, right?
But if throughout the whole year you only see two or three deals, beggars can be choosers, you only have a few.
Another reason, and it's going to lead me to the next rule, another reason why you want to have a great deal flow, a significant deal flow, is because it builds up your network and also your nerve to be frank.
It builds up your network and that's going to be my next point.
Network of other investors, network of start-upers, network of relationships, and again, whatever you do, be it cooking or golfing, you need a network, you need connections, you need an understanding of how things are working in a specific segment in a specific industry.
And if you do a lot of deals, you're going to meet a lot of people, you're going to make some hopefully friends or just some context, and this is going to help with the next important rule.
The important rule is build your network, build your network of fellow investors, build your network of entrepreneurs, talk with them, help them, try to be constructive, try to be helpful in whatever they're doing,
and the more you do that, the greater deal flow you're going to get, and the more you would learn from that.
One very important thing that I learned is also that you should always have enough of self-deprecation, you should always have enough irony that is addressed to yourself.
In other words, don't ever believe you're the smartest person, because chances are none of us is the smartest person, there's always somebody smarter in something, maybe you're a Nobel Prize winner in math, by the way, who knows, maybe you are.
But that doesn't make you a Nobel Prize winner in sales, maybe you're a Nobel Prize winner in sales, so to say, but you don't know much about product management or programming or public relations and a whole bunch of things.
In other words, try to listen, the smarter people are, the more they listen, the sillier they are, the more they deliver lectures, like I've just delivered here.
So in other words, try to learn as much as possible and not to teach as much as possible as I do. But on a more serious note, these are very important rules when you're investing, I'm going to add a few more.
Another one is due diligence. Don't just trust people, ask questions, ask tough questions, and expect that your fellow entrepreneurs will answer them, and if they don't, and especially if they get offended, and if they get silly and defensive, that's not a very good sign, because you want to work with people
who will be listening, you want to work with people who will be sharing their reports from time to time, monthly or at least quarterly, so that you would be in the know of what's happening in a specific company.
Last but not least, and it's really, really very important, whenever you invest, try to stay in touch with people in whom you invest it. Try to be helpful to them, try to offer introductions, advice on business models.
Of course, if these advices are not needed, you can't really impose, but if these advices are appreciated, if the founders say, oh yeah, can you please make an introduction to the right people in PR?
Or hey, here's the business model we've been using so far, do you think we can improve it?
Or hey, it seems like we have a significant problem with free to pay conversion, things used to be fine, but right now they're getting worse and worse.
Or hey, our customer acquisition costs seem to be growing across all the channels, what should we do?
So in every instance, whenever a founder wants your help, be helpful.
Well, first of all, because you want to be a good person, but secondly, because founders would appreciate it, and you would also learn a lot while helping founders.
So in general, let me try to wrap up and more or less formulate what are the best rules in investing, but also I'm going to add this little impromptu lecture with the golden rule.
The golden rule, the golden rule of growth, but before I get to the golden rule of growth, let me wrap up by repeating the main point.
So first of all, you want to invest because you want to make money.
Secondly, it's totally fine and great to invest because you want to play, you want to enjoy your life, and I think it's a great motivator.
Just keep in mind that the only way you're going to make money is if you're serious about it, unless you're lucky, of course, but it's hard to come just to luck.
And try to focus on numbers.
It's very important to do due diligence.
It's super important to have a significant deal flow.
It's important to operate only with numbers with actual numbers and not with great plans and great promises and these great, huge going up in the sky curves that entrepreneurs have.
And it's also very important to build a network.
It's very important to be helpful and it's really important to focus on learning things and on delivering some value, some context, some advice, or agreeing to be a little bit more important to build a network.
So, last but not least, the golden rule of investing.
For 15 years as an angel, for 12 years as a VC, I've seen lots of exits, dozens of exits where I was an insider, does not have a lot of access to the internet.
The insider, dozens of exits that friends of mine or my network had.
And again, with the exception of high tech, with the exception of space, pharmaceuticals, alternative energy, etc, companies are very, very rarely being bought for their tech.
These times are almost gone.
Yes, from time to time they are, but this is a tiny percentage of all the companies acquired.
The majority of companies exit via an IPO or an M&A, not because they have great technologies.
They exit because they manage to build a great business.
And so whenever a company acquires another company or whenever a company goes public, the most important sentiment, the most important dimension, sorry, that everybody focuses on investment bankers, individual investors, corporate investors,
private equity, etc, etc, the most important factor is the proven ability of a company to scale, the proven ability of a company to grow fast.
Whenever you're selling a company and you're dealing with a major buyer or with a public market, if a company goes IPO, the most important question on the mind of a buyer is, okay, well, right now I'm paying, let's say, 500,
I'm investing at, if this is an IPO or I'm paying, $500 million for a company with $50 million in revenue, so it's a 10x.
What am I getting for three years from now?
Is this company doubling every year?
If the company is doubling every year, then in three years it will be multi-hundred million dollar company and buying it at 500 million is a bargain, right?
If the company is not growing, well, it's a big question, you know, if a company is not growing, then is there really a great market feat?
Aren't there competitors who do much better than this company?
Should I really be buying this company?
Could this technology be outdated?
Is this team capable of adding to my top line or bottom line, will my stock grow if I'm buying them or will my shareholders say, oh my God, what a horrible acquisition, etc, etc.
So the golden rule is to invest in companies that have proven that they can grow fast.
Just like at the very beginning of this little lecture, I mentioned that it's really easy to find super early stage startups, they're everywhere.
It's also very easy to find not growing startups or startups growing at like three or five percent per year if they're late stage or like ten, fifteen, twenty percent if they're early stage.
The golden rule is if you're investing at around round A, you really want companies at least doubling per year.
So if a company had a million dollar, year one, it better had two million in year two.
If a company had five million, it better had something at least close to ten million.
Of course, as the companies grow, by the time they get to at least ten million dollars in annualized revenues, you can forgive a company not doubling every year.
You could be fined with eighty, seventy five, eighty five percent growth.
As the company gets to a hundred million, even fifty percent growth is very impressive, right?
Because you get a two hundred million dollar in revenues company in a year, it becomes three hundred million and two years, it's four hundred and fifty million.
If a company grows fast, they are much harder to find, only a very small percentage of companies grow fast.
If you find round A-ish, so a million dollar annualized revenues are so company growing at two x, that's a good deal.
If you find a company growing at three x, that's a great company.
If you find a way to invest in this company, the golden rule that I want to insist on is try to find fast growing companies.
Fast growing companies are the companies that the most experienced, the wisest investors try to invest in.
Why? Because in a year, in two, in three, in four years, this company, this specific company or these companies would grow three times, five times, twenty times, thirty times, etc.
And if you invest in a slowly growing company, very high chances are a company would not have great DNA growth, great DNA growth, great growth DNA, pardon me.
Or a company does not have a great market feed, and or a company would not be something that potential buyers or public markets would really appreciate and would price very highly.
So thank you for listening to this lecture. Hopefully you would find it useful.
Hopefully you will follow the golden rule of investing. And I look forward to speaking with you. Please write to us at the garage.
We're happy to talk with investors. We're happy to share with little wisdom.
We have gathered over many years. And thank you very much for watching this video. Have a great day.