Many people who would like to invest in startups are held back by one thing: They are afraid to commit capital for several years. In this article, we look at the best strategies you can use to overcome this problem.
Who wouldn’t want to invest in young companies that become great success stories? And by doing so, help bring technology that improves people’s lives to the market?
If you are comfortable enough to think about wealth creation, not just wealth preservation, you can afford to think long-term. This ability sets you apart from other investors.
But there are several reasons why many investors with the means for it don’t invest in startups at an early stage. One of them stands out: Illiquidity.
This technical term describes the fact that shares of a private company or startup are hard, if not impossible, to sell. Stocks are considered liquid assets: you can sell them right now if you need the cash for something else. That’s nice; everyone likes the freedom to change their minds.
Things are different if you buy shares in startups. Your only way out is when a startup gets bought by a bigger company or goes public. Only then, after a liquidity event known as an “exit”, do you get your money back. You also don’t know when and if it might happen. An analysis by Verve Ventures of Swiss exits in the past two decades shows that the median time to exit was 6 years (see chart below).
This sounds scary enough for most people to say: “That’s not for me.” After all, who knows what the future will bring? If you think of your wealth as a safety net, as a way to deal with life’s emergencies, you want liquid assets.
However, for people that assume the worst, no amount of money will ever be enough to make them feel safe. They shouldn’t invest in startups. Because the mindset of the startup investor is optimistic by nature. How else could you be able to comfortably imagine that a group of young entrepreneurs can take an idea and turn it into a business worth millions?
Think about it from the investee’s perspective. Listed companies don’t care too much about individual investors selling or buying shares. For a startup, your investment does make a difference.
But how to deal with illiquidity?
Start small, start slow, and start now.
Starting small means sizing your individual investments with the goal of making at least a dozen, preferably more investments. What small means depends on your total wealth and the portion of it you want to dedicate to startups. For some investors, a single investment of EUR 10’000 is small, for others, it’s EUR 500’000. Diversification is your friend, and this is true for startup investments in particular. The larger your startup portfolio is in numbers, the higher your chances of investing in a company that achieves outsized returns for you.
Starting slowly means deploying capital over several years. There will be very interesting opportunities you don’t know about yet. So no need to rush it and think that you need to rapidly build up a portfolio. Spreading your investments in time will also give your investments time to mature. The feedback loop of investing in startups is glacial. Stocks move up and down every millisecond, but growing a young company takes years. Constant slow investments allow you to learn and adapt your way of thinking.
Finally, the sooner you start, the sooner you will have your first liquidity events. By then, ideally, you’ll have a portfolio of startups at different stages. You’re still invested in an illiquid asset class on an individual level, but exits start happening at a more regular interval. On aggregate, your portfolio isn’t that illiquid anymore. You’ll be able to recycle the exit proceeds for more, and hopefully, even better investments.
In some cases, you might be able to sell shares of startups before they get acquired or go public. New institutional investors want to deploy large sums of money, and offer to buy shares of existing older investors. Once again, your options increase.
In quintessence, startups are an illiquid asset class. But there are ways to address this challenge if you have wealth that exceeds what you need to cover unforeseen events and if you have the patience, and optimism, to start small, start slow, and start now.
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Eugen Stamm joined Verve Ventures in 2018 and covers startups and investment topics. He has invested in more than 30 startups and joined the board of directors of a fintech startup. Eugen has more than a decade of experience in financial journalism (including working for Neue Zürcher Zeitung) and wrote a book about family governance. He is an official partner of Bergos AG.
* Bergos is not responsible for the content of the guest article and does not necessarily reflect the opinion of Bergos and the statements expressed herein do not constitute investment advice. Investments in Start Ups are risky and are only available for qualified investors.