Expect to lose and win big investing in startups

The truth about diversification

So far the most fun I’ve had getting divorced is re-hauling my investments and analyzing how to breathe life into a stale portfolio and diversify it.

I had a traditional portfolio of real estate and stocks, but being part of the tech world for 20 plus years, I want to invest in startups. When I was married, I thought investing in startups was for the uber-wealthy and venture capital and angel investing insiders. It felt exclusive and risky — an alternative asset class where losing is part of the strategy.

Venture capitalists leaders highlight how often you lose before you win. Thought leader Fred Wilson of Union Square Ventures says,

“Investing in startups is risky. If you make just one investment, you are likely going to lose everything. If you make two, you are still likely to lose money. If you make five, you might get all your money back across all five investments. If you make ten, you might start making money on the aggregate set of investments.”

How Much to invest

That being said, no one will advise you to put a large percentage of your savings into early stage companies. However, if you allocate 5% of your overall portfolio into startup investments you can increase returns and reduce risk. According to a SharesPost whitepaper if you allocate 5% of your investments to private growth companies you can increase the returns of a traditional portfolio by 12%.

Successful venture capital firms generate approximately 80 percent of their returns from less than 20 percent of their investments. So I know my odds are 90 percent of my cash returns will come from 10 percent of the winners.

How Many to invest

The next question is how many companies should you invest in to create a diversified startup portfolio. Experts from the Kaufman Foundation “Returns to Angel Investors” report and Dave S. Rose in his book “Angel Investing: The Gust Guide to Making Money and Having Fun Investing in Startups” suggest investing in 12 to 15 companies to generate a 2.6 time return on your investment in three to five years.

According to the “Siding with the Angels” report by Nesta, of the ten startups they recommend as the minimum number to invest in: 1 or 2 businesses soar, 2 or 3 will do OK, and the rest will fail. Again, if done properly, the returns can far outweigh the losses, allowing investors to generate around 25% ROI per year.

What Criteria to invest

The final question is what is the basic criteria to create a diversified startup investment portfolio. Fortunately many online investing platforms, including my company OurCrowd, has startup investing funds where you can invest $50K into 20 companies that experts choose and manage.

But if you have the time and the interest to choose the companies, you can do it with these three basic rules. Each of the companies should range in 1) the stage of the life of the company (based on time and progress), 2) the industry or sector (advertising, financial, health and wellness, cyber security, e-commerce, mobile, etc.), and 3) geography (US, Israel, India, etc.)

In the future I’ll write about specific criteria on how to evaluate and choose startups. But a good rule of thumb is you should invest in ideas you understand and select every investment as though it’s your only one. If you lower the bar you will only build a bad portfolio.

Because of my founding role at OurCrowd I’ve got it easy to build my portfolio. Two ½ years ago I became part of the global movement of online investing platforms that enables qualified investors to invest as little as $2,500 per company.

To start creating your own startup investment portfolio I encourage you to visit the online equity crowdfunding platforms that allow you to invest in vetted startups alongside other angel investors and venture capitalists.

First time investors need to remember that backing private startups is risky and is very different than investing in public stocks. Risks aside, there are strong reasons for smart investors to diversify their portfolio and allocate a small percentage to startups.

Being single now means I control my financial destiny. I want to make money and invest in the future. I expect every startup I invest in will be a winner. Most of the time I’ll be wrong, but when I’m right, I’ll win big. Want to join me?