Editor’s note: Today’s Money & Markets Daily features another article from Crowdability’s Matt Milner. A former Wall Street executive, startup founder, and venture capitalist, he now helps ordinary people invest in and profit from private startups. Check your inbox to find out how you can follow Matt and his team at Crowdability for amazing opportunities. Enjoy!
3 ways to make money investing in startups
On a late-night flight to Argentina, a cheery stewardess was giving a familiar speech.
Her soothing voice was a pleasure to my ears as I sat by the window reading a business plan for a tech startup.
“There are ten emergency exits on this Boeing 777,” she is heard saying, “four at the front, four at the back and two over the wings.”
The business plan I was looking at was interesting – they had a great team, an interesting product, and some early traction – but something was bothering and bothering me.
The stewardess continued, “Remember, the nearest exit may be at the back.”
When she finished her presentation, I looked around for an emergency exit and as I fastened my seat belt, I suddenly realized what was bothering me.
There were 10 emergency exits on this plane. The crew knew exactly where they were and how and when to use them. They had a solid escape strategy.
However, the startups I was reading about had no “exit strategy” whatsoever.
In other words, there was no way to “exit” the investment and make a big profit.
Exit strategy
Investing in early stage companies is fun and exciting, and it’s always a pleasure to see dreams become reality.
But to make money, you need an outlet.
Essentially, you start investing by writing a check, and to get out of it, you have to get your money back, or hopefully, a multiple of your money (we aim for a 10x return on all our startup investments).
So, if you’re considering early stage investment, one of the most important questions to ask is:
“What is your exit strategy?”
3 ways to make money investing in startups
There are multiple exits on a plane: two here, two there, two in the back. They’re everywhere.
It’s the same with startups. There are three main ways a company exits:
1) A startup gets acquired by a larger company.
2) The startup goes public through an initial public offering (IPO).
3) Once a startup is profitable and determines it doesn’t need all of that cash to grow, it can return funds to shareholders in the form of dividends or distributions at that point.
Odds
If you invest based on probability, you are unlikely to reap the rewards through dividends or an IPO. Very few startups pay dividends, and even fewer achieve the scale and stability to go public.
What’s your best exit strategy? Acquisition.
Searching for clues
Unlike an airplane, exits for a startup aren’t always clearly marked.
But the clues are usually there.
Clues could be a big market, or a sector that’s growing like a weed, or one or more acquirers ready to write a big check.
Here’s an example that you may be familiar with:
By 2012, Facebook had nearly one billion users, many of whom spent hours each day on the website.
Meanwhile, two major trends were gaining momentum. First, consumers were spending significantly more time on their mobile devices. Second, consumers were becoming obsessed with taking photos with their phones and uploading them to sites like Facebook.
So in April 2012, Facebook acquired a privately held startup developing a photo app called Instagram for $1 billion.
What on earth could Instagram have that would make it worth $1 billion?
First, the company was targeting a huge market: everyday photographers, second, the company was on the leading edge of several emerging areas, including mobile, and third, several potential acquirers, including Facebook, Twitter, and Yahoo, were eager, even desperate, to expand their mobile efforts and could afford to write big checks.
Why I “passed”
In contrast to Instagram, the business I was reviewing on the plane had absolutely no signs of a possible withdrawal in the future.
It was targeting a small, niche audience. There’s no way it’s going to reach a billion users. It’s going to be hard to scale to 10,000 users.
It wasn’t part of a fast-growing sector like mobile.
And it’s hard to imagine a bigger company buying it – there’s not much to buy: no large customer base, no proprietary technology, for example.
There was no exit strategy.
So, it was a clear “pass” for me.
Always exciting
Investing in a startup that doesn’t have a specified exit strategy is like getting on a plane with no clearly defined exit.
So when it comes to investing in startups, make sure you ask yourself, “What is the exit strategy?”
Enjoy your investment.
thank you,
Founder
Cloud Ability
