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One of the most frequent things I'm asked is about how to invest in 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% to 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...[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]
Signal No. 1: 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 that 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 No. 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.
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 No. 3: 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-plus) 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.
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