I said it in a previous blog. And I will say it again.
Never, ever be pressured into investing in a private start-up. This is not a game for regular investors. Venture capitalists and investment banks lose billions and they have really smart people vetting the deals out. The vast majority of start-ups, probably in excess of 90% do not return a cent for their investors. There are just too many moving pieces that need to be perfectly aligned for a start-up to get to sustainability to get to saleability. Yes, there are diamonds in the rough but just like actual diamonds in the rough, the chances of you hitting one is in the realm of lottery odds.
Don’t get me wrong. I’m an absolute supporter of entrepreneurship. I’ve been one for the last 5 years, ironically helping start-ups find money. I’m small fry so I don’t get a sniff of the big deals but small raises under 1M are common. And this is where average investors lose their money. If your friend or nephew is asking you for money, invest because you love the guy. Don’t invest because you think you’re going to stumble across the next Sergei Brin or Mark Zukerberg. It could happen but the odds are astronomically stacked against you.
I’m not an investment guy nor an accountant so I don’t have any advice to give. I just help with pitches. But after a couple of years of this, in Canada and in China, I refuse to help raise another nickel from a private investor for another private venture.
1. Most management teams exaggerate their ability. Anybody can write a sweet sounding biography. They know you’re not going to check. The really big names in the industry are already engaged in something and are talking to VCs and IBs, not you. They’re not asking for your $100k. They’re asking for a capital group’s $5M or $50M. What that means is most start-up management teams and advisory boards are made up of people just like you; decently talented and well-meaning but rarely the superstars they claim to be. I remember the principal of a small biotech snarking at me, “I can raise $5M with my name alone.” Then why are you coming to me to raise $500k? He ended up getting funding from a colleague of mine. As of today, 2 years later, not a nickel in revenue has been produced. Luckily for my colleague, all funds are in escrow with high gates to hurdle…none of which have been hurdled thus far.
2. The economy is moving too fast for the average investor to be able to predict anything. Our current rate of technological advancement would blow the minds of every single super genius that ever lived before us. If some guy tells you he has a product that is so awesomely unique that there are absolutely no competitors, he is either delusional, lazy or lying. Anything you put out there can literally be bettered by someone else within months. Are there new products? Of course there are. It’s just that the chance you’ll stumble across a market-rocking one is a million to one. If you’re talking apps or software, it could be obsolete before the ink on the subscription form dries. If the big banks only get 1/3 (if even) of their gambles right, what chance do you have?
3. No matter how much due diligence you do, it’s mostly B.S. Start-up business plans and projections are written based on hopes and past data. No amount of due diligence a regular guy can do will ever satisfy all the questions that need to be answered. That’s because the answers do not exist. Everything is based on best guess, from market receptiveness to size of market to how long their current burn rate will last them if they can’t sell something within 3 months. I remember the CFO of a bomb-detection company sneering at me when I said the investor needed more info. “She has the term sheet. What else does she need to make a decision?” TIP – If the company reacts to your request for more information with hostility, it’s a red flag. They have no answers and they are trying to dissuade you from asking more questions.
This is your money and I’m telling you straight up, private placements are not for regular investors. And yet this is generally where start-ups go first; friends and family. It’s for capital firms that make money by taking chances and experienced angel investors. There are no rules to protect you. If you are an accredited investor (all you need are sufficient assets to qualify), you’re free to toss whatever dollars you want at a private company and if it goes belly up, you are S.O.L. Yes, some of the brands you see today might have started because one buddy funded another. But it’s so rare, I bet you can’t name more than one or two without diving into Wikipedia.
A good pitch guy will aim past your logic and try to engage your sense of possibilities. No matter how awesome the pitch guy is, you control the money, so you control the pace.
Know the odds for private start-ups. Then decide to put your money somewhere else.