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How To Invest In Startups – Part 2

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    Welcome back. This is part two of Silicon Valley Investors Club’s guide to getting started in startup investing. 

    In part one of this guide, we talked about the first two steps of startup investing: to create a startup investing budget and to determine your target market. In part two of this article, we will talk about steps three and four of getting involved in startup investing: to build your startup funnel so that you can develop deal flow and to craft an investment decision process. 

    Step #3: Build your startup funnel

    As with any “private equity” business, the key is to build a funnel of potential leads [in our case, startups to invest in] and run a disciplined process to determine if these leads fit your criteria. This is no different from hiring, sales or online signup flows that any professional is likely familiar with. 

    After you have a clear idea about what it is you want to invest in, how much you are prepared to invest, and how many projects you intend to invest in, the next question you will have to consider is how you are going to find those startups. 

    Public markets are about analyzing and evaluating if an asset is undervalued or overvalued. You can be a math wizard and invest in public markets easily with the click of a button from your bed (in your pajamas) and still beat everyone. In the startup investing world, if you don’t know how to source and gain access to invest, then your smarts don’t matter very much. 

    There are many ways to source startups. You just have to find your own edge. For example, while Tim Ferris uses his books and podcasts as his sourcing channels, Vela uses an internally-built Google-like search engine to source startups. 

    If you want to begin sourcing your own startups, follow these instructions:

    1. Let the world know that you’re an angel investor. 
      • Create your Angellist account.
      • Update your LinkedIn profile to make it clear to founders that you are interested in investing in startups.
    2. Join investment communities such as Silicon Valley Investors Club or alumni groups such as Xoogler.co. Then, build relationships with startup founders, angel investors, and venture capitalists. 
    3. Go to demo days of accelerators and learn how to engage with startups in a casual setting. 

    After you complete the steps above, you’ll become more aware of your edge. Here are some examples of what this looks like in practice:

    • If you’re a software engineer, then you can build an algorithm to source developer tools startups. 
    • If you’re a product enthusiast, then you can be active on ProductHunt with reviews and hunts.
    • If you’re an expert in HR, then you can be active in everything relevant to that field: attend meetups, organize events, write blog posts, become a speaker, and build relationships with VCs and angel investors who invest in HR. 

    Keep in mind that you must be patient because it will take months or, more probably, years to build your startup funnel.

    Moving Startups Through Your Funnel

    As you begin talking to founders, you will need to keep track of who you speak with. A simple Google sheet should help you accomplish this when you’re just starting out. The reason you want to track who you speak to is that after some point in time, you will have a large number of startups that you’ll be engaging with and you will need this system of record to help you analyze the funnel and keep existing relationships fresh. 

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    The Four Phases of Your Startup Funnel

    • Unqualified leads: These are startups that you come across through Linkedin, demo days, recommendations from your network, solicitations from founders, or your own unique sourcing channel, but that you haven’t had a chance to look at critically yet.
    • Qualified leads: An unreviewed lead changes to a qualified lead when you have spoken to the founder or read their pitch deck and decided that their company might be a fit for your investment criteria. Qualified leads are startups that you have looked at and decided that you might be interested in investing in. Less than 10% of unqualified leads become qualified leads. 
    • Opportunities: A qualified lead becomes an opportunity once you have had time to have a deep-dive discussion with the founder and conducted due diligence on the company.
    • Investments: We will talk about how to think about making an investment in step four.

    Most VCs invest in 0.1%–1% of the startups they see. Put another way, a typical venture capitalist will invest in somewhere between 1 and 10 out of every 1,000 startups they investigate. What this means for you is that you should be patient when making your first investment decision. At the very least, you should evaluate 100 startups and benchmark them before making any concrete investment decisions. 

    Step #4: Create an investment decision-making process

    Now that you can find startups, how do you invest?

    Each startup has pros and cons. All startups, great or terrible, will be rejected by hundreds of investors. Some investors will reject a startup because of its location, stage, or lack of traction. Sometimes startups are rejected because their idea just doesn’t resonate with the investor. Other times, still, an investor may have some personal reason for rejecting a startup. You have to personally determine how you will weigh each pro and con.

    Some investors prioritize teams, while others prioritize growing markets. Depending on the stage at which you invest, it’s also common to evaluate the progress a startup has achieved so far. The more the company progresses, the more expensive the startup will be, and the harder it will be to invest in the company at a reasonable valuation.

    At Vela, we have three key initial screening criteria: thesis-fit, team-fit, and 100X+

    1. Thesis-fit: Can we intelligently evaluate this startup? Do we have an informed opinion?
    2. Team-fit: Is this the right team to execute this venture?
    3. 100X+: Do we see a 100 times or greater return potential in the market that the startup is operating? In other words, for seed-stage startups, can the beachhead product of the startup generate $100M annual revenue?

    Like any recruitment process, the next steps of startup investing are to run an interview process, deepen the analysis, and evaluate the startup in various other sub-dimensions. At Vela, we prepare a scorecard for each qualified startup and write an investment memo to articulate our thoughts and weigh the pros and cons. Running the same process for many startups helps you weed out the bad investments and, more importantly, enables you to separate the great from the good. 

    Unlike almost any other recruitment processes, though, startup investing is a two-way interviewing process. How you build your relationship with the startup founder matters. Being transparent, friendly, fast, well-prepared, and capable of demonstrating your edge are all important attributes that will grant you access to invest. If you’re a business development, sales, recruitment, or partnership professional, then you have an added competitive advantage in this part of the process because this will all be natural to you. This is essentially a partnership business more than an investment business. 

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    How can I do all of this if I am a full-time professional?

    If you’re serious, then I recommend that you make startup investing your only hobby outside of your primary job. Like all great things, startup investing requires an ongoing time commitment. (It may very well consume your other hobbies, anyway.) At the very least, I recommend that you carve out a minimum of 5 hours from your weekly schedule to engage in investing.

    You also need to determine what your investing goals are. What do you intend to gain from startup investing? For reference, some people invest with the goal of learning how to become an entrepreneur, others invest to expand their networks, and still others invest solely as a financial instrument. 

    If investing is mainly a financial instrument for you, then focus on networks with the highest return on investment for your capital and time. Here are some definitive ideas about how you can get started, from the highest effort to the lowest effort, in descending order:

    1. (High Effort)Build your proprietary deal flow to source and invest.
    2. (Medium-High Effort) Attend YCombinator/500/Techstars demo days and invest in a few startups in each winter and summer batch.<
    3. (Medium-Low Effort) Evaluate and invest in syndicated deals one by one on Angellist.
    4. (Low Effort) Invest in a venture capital fund.
      These actionable steps will help you get started with startup investing. Remember, startup investing is about sourcing as many startups as possible and then having a logical decision-making process to filter out the weak ones effectively. If you don’t spend the proper time preparing yourself to invest in a startup before you actually begin investing, then you will most likely get randomized and be likely to drop out quickly. If you read this far, then I expect that our paths will cross someday. For now, though, I wish you the best of luck in your startup investing journey.This content is for informational purposes only. All views contained herein are my own and do not represent the views of Vela Partners LLC (“Vela Partners”) or any Vela Partners affiliate.

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