We talk a lot about value investing here at Stocks4Docs but there are many other types of investing. You may be curious, as we are, about private equity investing.
The big-name IPOs grab headlines. They secure 10x returns for their investors and bring innovation to the world. Do you have what it takes to become a private equity investor in some of the most bleeding-edge companies in the world?
This week, we speak to Mahendra Ramsinghani, a successful venture capitalist and friend of the show, all about investing in startups. Here are the big takeaways from our episode:
Is Private Equity Investing Right For You?
Most of us begin our investment journey in the public arena because it is so simple. Online brokerage platforms make it easy to invest in companies we recognize. Stock analysis is widely available at a click of a button. Value assessment is also already calculated for you by industry experts.
The startup arena is far more complex. As Mahendra says, there is a lot of risk and effort involved, but the returns can be astronomical if you strike gold.
If you are considering investing in private equity opportunities, Mahendra suggests you ask yourself these three questions:
1. What is my appetite for risk?
There are two main investment types in the startup sphere: early-stage and later-stage.
Later-stage investing is the safer option. This is when a startup has already had at least one or two rounds of investment and there is traction in the market. You are making a safer bet that the company will continue to grow, but the asking price will be higher.
Early-stage investors acquire the most risk. They are pouring in money into an idea that likely hasn’t been validated in the market, with founders who have never run companies before. However, this is when startup investing is at its cheapest. Early investors stand to make the largest return.
2. Which sector do I want to invest in?
Stick to what you know. It makes sense to invest in companies that operate in a field you are familiar with. You are only increasing your risk of a bad investment if you invest in a company completely out of your Circle of Competence.
3. What will my asset allocation be?
Mahendra doesn’t advise putting all your eggs in one basket. If 60-70% of your portfolio is in public stocks, perhaps 10-20% could be in venture capital funds.
How Do You Assess Potential Investment Opportunities?
Many don’t venture into venture capital because analyzing risk is much more complicated. Mahendra outlines the following steps to see if an investment opportunity is right for you:
Assessing the founders of a startup can be more difficult as often this is their first company. They could be complete philanderers (like Elizabeth Holmes of Theranos) or just plain incompetent.
You’ll want to look into the background of the founders. How well do they understand the problem and do you trust that they are the people to solve it?
- Market size
Does the company have huge potential in the market?
Mahendra gave a great example; imagine an innovation for incubators that could impact all of the incubators used in hospitals worldwide.
That would be a company with huge market potential.
- Prior investments
If the company is post-seed round (that is the first round of investing for startups), have a look at the caliber of investors that are involved in the company already. Sometimes even seed round startups have notable advisors on their board that give them a vote of confidence in the space.
3 Ways To Start Investing In Private Equity
1. Solo investing
If you have the time and knowledge to do your own stock analysis, as well as nurture founder relationships, solo investing is completely possible for you.
There are marketplace-like platforms such as AngelList that make it easy to review investment opportunities in your sector.
After reviewing the listings, you can reach out to the founders to set up a meeting. They will show you their pitch deck, encompassing their vision for the company and their ask.
It is always best to take things slowly. Start investing small amounts at first.
Mahendra admits that his first 10-20 investments were quite mediocre! It takes some practice to see the real gems.
2. Small Venture Capital Funds or Angel Groups
For those of you who don’t have the time to do all of the analysis on your own, you can team up with a group of angel investors or join a small venture capital fund.
Venture capital funds will take a percentage fee for their services, but they simplify the process hugely. They often reliably see annual returns of 30-50% from their carefully chosen portfolio.
3. Large Venture Capital Funds
If you are well-known in your space and can provide a lot of value to portfolio companies, you could apply to be a part of larger venture capital firms like Sequoia. They cherry-pick the investors they work with so this option has the highest barrier to entry.
To learn more about the exciting world of venture capital investing, check out Mahendra’s book, The Business of Venture Capital.
Looking for more information about the stock market, value investing, and more? Please check out the Stocks4Docs Podcast.
Mahendra Ramsinghani is an Investor in technology companies for over a decade. Author of two books – The Business of Venture Capital and Startup Boards (with Brad Feld).