David Weisburd here.

One of the most frequent things I’m asked is about how to invest into startups at the earliest stage.

This is because early stage investing offers the highest potential return on capital of any stage of investing. All things being equal, investing in a seed-stage company at a $5 million valuation can produce a return 20X larger than investing in the very same company once it’s worth $100 million (Note: dilution can decrease the former return by 20-25%).

In real dollars, that would mean the difference between $100,000 returned on a $1,000 investment vs. $2 million returned on the same $1,000 investment.

That being said, investing in startups at a very early stage has a very high level of difficulty. This is because at the earliest stages of a startup’s history, you have the least amount of data from which to make a decision.

So how do you go about picking the best early stage startups?

The short answer is that you can never know which early stage startup will bring you the highest return, but there are certain signals that can help you increase your chances of success.

Here are the three signals that I rely on the most when making the decision to invest…

Signal #3: Do I have the urge to quit my day job and join the startup?

The very best startup founders inspire so much excitement and confidence from investors that they almost convince you to quit your day job in order to join their startup.

At its core, this is an emotional drive which is only rationalized by our logical brain.

Note that this litmus test isn’t “Would someone else quit their day job” but rather, “Do I feel the urge to quit my day job?” It’s easy to imagine others quitting their day jobs to join a startup, but the question is, would you?

Signal #2: Is there serious Founder/Product fit?

Contrary to popular opinion and some headlines, the best startups are started by founders that have spent a minimum of a decade within a given field.

That’s because the best startups come from a very nuanced understanding of the customers, suppliers, and the ecosystem in which a company operates – including many factors that appear trivial to the untrained eye.

Text Box: Earned Secrets: Secrets that are This is what we call earned secrets in Silicon Valley.

It’s nice if someone has a Harvard or Stanford degree, but it’s even better if they come from Carnegie Mellon’s Robotics Institute and have founded an autonomous trucking startup.

Startups are all about domain expertise, and the best founders have very relevant and specific domain experience.

Signal #1: Do the founders have skin in the game?

I always ask myself a series of questions when it comes to earliest stage startups.
  • Are the founders all-in when it come to the startup?
  • Are all the founders pursuing the startup full time?
  • Are the founders investing their own (and grandma’s) money into the startup?
  • Are the founders taking a salary cut?
These all seem like trivial questions, but they are the best ways to really drill into the head of the founders and see the level of confidence the founders have in their own startups vs. how confident they say they are. Talk is cheap. In order to gauge a founder’s own confidence, follow his or her behaviors, not their words.

These are the three top signals that I personally use in order to quickly vet early stage investment opportunities. Remember, the key to having great early stage returns is to diversify, diversify, diversify. Plan to make a minimum of 15 (and ideally 30+) startup investments in order to generate a predictable return.

And don’t go anywhere… I’ll be back soon with more of my favorite strategies.

Very best,



David


Comments

23 responses to “3 “Must-Haves” I look for When Investing at the Earliest Stage”

  1. Yes agreed with all 3 signals of a good startup. Many start up founders try to start a company with a fast intention to sell their company very fast with huge profits in mind.

  2. As always thanks again! Keeps me eager to get another insightful lesson! Thanks for the tips! Keep em coming we are allllll ears!!

  3. I agree with the diversification advice, and when I last looked at the data, 20 investments should provide “full” diversification (if you include all sectors). That said, your average return is also much lower than that of the “star” performers, if any, you have been able to include. Mark Cuban, of Shark Tank fame, revealed he had yet to make above-market returns on his investments from that show (which may just underscore the need to vet those investment opportunities better).

  4. The three must haves are great question. Angeles & Entrepreneurs sounds great now put your questions in front and find the answers to work for you.

  5. Exceptionally relevant but simple advice for new angel investors such as myself to follow. Are these articles archived on the A&E website to review for future reference?

  6. All I can say is thank you David for all the information, I’m new on A&E and I can’t wait to learn more and more and choose the the right startups to invest…..

  7. I just signed up as a life time member for the Angels & Entrepreneurs the other day. However, I have no idea how to start investing.

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