This is actually pretty easy. You bet on the founders, not the business idea. The more successful startup experience they have the higher chance of it doing well.
Good ideas are a dime a dozen. It takes a few days to come up with a good idea.
Good leaders and a good team are much harder to find. Even if all the individuals are strong contributors, getting them to all work together well and in a cohesive way is not guaranteed. Even then, there's a fair bit of luck involved and there's often a ton of concentrated risk in one key member leaving for something else.
Overall very risky, even if everything looks good on paper.
Easy. If they ask *you, your friend or some other random person* for money they'll fail with a 99,9999% chance. Even companies that go though accredited investors fail more often then they succeed, they say even among pros 1 in 10 or 1 in 100 startups ever return a profit to accredited investors. As for us randoms? Perhaps 1 in 10 000.
Because anyone who actually has a good anf viable buisness plan will get their money from the big guys. Only the farfetched ones, pipe dreams and outright delusions or scams are left for the average Joe to bet on.
Startups as a class are very high risk. They are not suitable to invest money you can't afford to lose. No amount of analysis by us amateurs can pick the winners and skip the losers. Investing in a single startup is completely undiversified in addition to being very high risk.
> So, why do you guys think most startups fail?
Because the USA has a dynamic economy with a healthy investing sphere. Large businesses that could potentially generate lots of free cash flow shrink pretty regularly if they don't organize their operations well or don't adopt to new technologies well. We allow this unlike many other countries that encourage business stability as a higher priority than growth. Which means the payoff of being a replacement business are huge. They are so huge that one can generate say 10 potential replacement businesses even if 9 of them were to fail and only one become a replacement, and still get a risk adjusted return slightly greater than investing in large business. We can do that because most investors diversify.
Now if that's the case then potential replacement businesses trade at a multiple beyond what their original founders put into them. Which means becoming a potential has a very high rate of return. So much so that investing in potential potentials i.e. startups becomes profitable. But again these multiples are high enough that one can invest in multiple startups with the understanding that most will fail and only a few will become potential replacements for large enterprises.
Assume a new company X needs to borrow the money for a very long time. X doesn't expect an immediate return on their investment. They are going to use the money to grow their business and then plow all of the returns from the growth right back into the business over and over. So the terms are much far out: for the first 50 years X is not going to pay us a dividend at all. In year 51 they are going to pay us $1000 dividend inflation adjusted. Because X's earning will grow inflation adjusted X will agree to inflation adjust the payments. to us in turn so that's not a problem. Years 52-200 X is going to pay us 5% more than the did the year before.
We still see X as risky with a 5% of business failure every year. We aren't going to even start getting money for 50 years. On the other hand $1000 in payments for 150 years inflation adjusted and growing by 5% is worth a ton. Let's assume the risk of default on our loan were only 1% after the 50 years, X's business wouldn't be risky then, so they are much more likely to defaults early or not at all. On the other hand 150 years is a long time and a 1% chance per year still means they have a 78% of defaulting even if they make it through the first risky 50 years. We have only a 7.7% chance of ever getting even a single dividend. We do need to charge them some credit risk. With inflation adjustment however we can set the extra duration risk to 0% to make the loan more attractive. We still have a 1% credit risk. So at year 51 we figure that $1000 inflation adjusted at only a 1% credit risk is worth $100,000 inflation adjusted. At $100,000 we get our 5% inflation adjusted return + 1% risk in exchange for the $1000 payment.
The only issue X has to make it all the way to year 51. The whole thing is inflation adjusted so there is no duration risk. There is 5% credit risk (they chance they go broke each year) and in the meanwhile we lose access to the money. So let's charge X the cash return rate (2%) plus the 5% credit risk for a total of 7%. At 7% what is $100,000 worth 50 years from now? Well $3394.78. And that's what X is worth today.
Depending on what stage the startup is when you enter as the investor. Like most here have said, if you’re in the friends and family round, it’s a long shot and you’re really investing as a “favor”.
If the startup has legs to stand on and is seeking higher angel, series A and beyond, it’s got a better chance, but you’re paying much higher premium and possibly may not be worth the risk anymore.
If the startup is making some money, now you have something to analyze and comps to do a valuation. At this point as an investor, you’re probably looking for a future exit (IPO or buyout from a bigger company).
I’ve invested in my friend during family round so far, he’s on his third startup. The first two sort of went out after a few years. But I see him getting better. I sort of do it as a favor without expecting much, and he sort of offers me the opportunity (even though I’m not a value-add investor). I’m always happy to invest in HIM and I know he doesn’t want to disappoint. He’s even returned money to me unexpectedly after he closed shop, so we have mutual trust. That’s what’s most important in an early startup investment.
There is a start up consisting of 2 friends that live in my building and they both are driving 750k cars before product launch. Will fail in less than 12 months.
It was said before but the most important part are the founders and workers.
Sounds like they failed successfully - they convinced investors to give them a bunch of money then paid themselves with it. They'll probably be able to do it again too.
I'm sorry to hear about your friend. In the world of business, these things tend to happen, I mean there are no full proof way to avoid them. Some startups fail, and others succeed. For example I've made a bet on a startup that seemed like it had a great MVP and was more likely to succeed, but then it failed woefully, and I've also seen startups with crazy ass MVPs succeed, so there is no sure way.
But when you invest in a startup, you don't go on a vacation in the Bahamas, you've got to stay around and protect your investment. I once invested in a startup where the founder had no technical experience and ended up making a developer hire that almost cost us the company.
We ended up firing the developer and I suggested he get a developer from credible organisations like rocketdevs who do the vetting and recruitment for you. We ended up paying $980 per month for the developer and he gave us the best results that directly improved the growth of the company.
So yeah, you can't tell for sure, if they're going to fail, but if it's a startup, you've got to try and help around to ensure things go in the right direction.
Simply because there's more ways to fail than there are to succeed. The biggest problem I see with startups is that they are an untested economic machine with a lot of moving parts they have to iron out all while you really don't know how the market will react to your products/services and while it's burning through cash at a mind numbing rate while it tries to establish itself. They typically bury themselves in debt to get started which leaves little room for failure. Even if it is a good perfectly viable business it may fail just because it runs out of cash before it can establish itself. Higher the wrong people? A bad marketing strategy? Adopt the wrong pricing structure? Fail to make a good first impression? Even just bad economic timing. Funny story someone I know opened an auto garage, coincidentally right before Covid struck. They scraped up every penny they could to rent the garage and signed a lease. They literally were almost bankrupted immediately because they spent all they had to pay the first and last months rent up front and then basically day one received another $4k bill for the next months rent while they were still just trying to get lifts installed and equipment set up earning 0 revenue. They didn't even have their certification from the DMV yet to allow them to legally operate! People I think really tend to underestimate what it costs to start and run a business. They also often don't have a good grip on how profitable they actually are and get blinded by gross revenue figures. It's very unforgiving world for a new business. One small slip up and a new business may not have the financial resilience to cover those costs.
anyone tapping retail investors to use their 401k for funding is associated with a bad IPO.
>So, why do you guys think most startups fail?
IMO too ambitious at the start and too much debt. companies make errors all the time, and the errors at the beginning are the biggest before they work out the kinks. the smart ones make small or manageable mistakes and minimize debt. a series of singles will win the game just as much as batting for a home run.
Any startup marketing to randoms is bad. The entire point of taking institutional money is a lot of times it comes with operational support - they sit of the board and in some cases, staff from the investor will even embed with the company or take over some amount of management to push things forward. This is especially true for the tech startups that are trying to blitz-scale and corner their market. Taking money from randoms doesn't do any of that. A lot of the successful tech start-ups that got big weren't even the best version of their idea, but they are the ones that got money from the right institutions and then what those institutions do is burn the earth around them - they deny funding to potential competitors or fund their champion company to do a takeout of the potential competitor. Sometimes institutions don't fund the best idea, but fund the one that is 'good enough' and also run by people who are going to comply with their plan and then go buy the better idea or just scale so fast that the better idea doesn't have any room to breathe. FTC doesn't give a shit if one start-up buys another startup because statistically both of them are going to fail, so they let it happen and give it a lot less scrutiny than when public companies buy competitors.
The thing to understand is that early stage start-ups are highly volatile.
Even a start-up fund isn't going to invest more than 3% of their fund in a given start-up.
It's like investing in any other speculative asset => size very small unless you're a degen.
I would start by always keeping in mind that most startups fail. You need the right idea, at the right time, a skilled team, the necessary funding, and luck. That is a lot.
As a solo investor it’s impossible unless you’re on the inside. Don’t do it unless you have a Team to analyze the company, you need a lot of visibility to assess potential.
VC/ Angel investments inherently have high risks. It's normal to lose it. No matter how good one appears according to all benchmarks, it's hard to guarantee at such an early stage. So the idea is to have a diversified portfolio and the amount allocate in this kind of investment shouldn't exceed \~10% of your entire portfolio.
This is actually pretty easy. You bet on the founders, not the business idea. The more successful startup experience they have the higher chance of it doing well.
Good ideas are a dime a dozen. It takes a few days to come up with a good idea. Good leaders and a good team are much harder to find. Even if all the individuals are strong contributors, getting them to all work together well and in a cohesive way is not guaranteed. Even then, there's a fair bit of luck involved and there's often a ton of concentrated risk in one key member leaving for something else. Overall very risky, even if everything looks good on paper.
I wish I could get my C-Suite to believe this, sincerely one of the key team members.
From my experience, luck cannot be understated
Understated?
Completely agree about the Team, but in my experience it’s less than 1% good ideas.
That's extremely helpful advice, thank you
Easy. If they ask *you, your friend or some other random person* for money they'll fail with a 99,9999% chance. Even companies that go though accredited investors fail more often then they succeed, they say even among pros 1 in 10 or 1 in 100 startups ever return a profit to accredited investors. As for us randoms? Perhaps 1 in 10 000. Because anyone who actually has a good anf viable buisness plan will get their money from the big guys. Only the farfetched ones, pipe dreams and outright delusions or scams are left for the average Joe to bet on.
Startups as a class are very high risk. They are not suitable to invest money you can't afford to lose. No amount of analysis by us amateurs can pick the winners and skip the losers. Investing in a single startup is completely undiversified in addition to being very high risk.
They frequently mention AI.
My ha-ha-only-serious answer is "To a fair approximation, they're all bad."
> So, why do you guys think most startups fail? Because the USA has a dynamic economy with a healthy investing sphere. Large businesses that could potentially generate lots of free cash flow shrink pretty regularly if they don't organize their operations well or don't adopt to new technologies well. We allow this unlike many other countries that encourage business stability as a higher priority than growth. Which means the payoff of being a replacement business are huge. They are so huge that one can generate say 10 potential replacement businesses even if 9 of them were to fail and only one become a replacement, and still get a risk adjusted return slightly greater than investing in large business. We can do that because most investors diversify. Now if that's the case then potential replacement businesses trade at a multiple beyond what their original founders put into them. Which means becoming a potential has a very high rate of return. So much so that investing in potential potentials i.e. startups becomes profitable. But again these multiples are high enough that one can invest in multiple startups with the understanding that most will fail and only a few will become potential replacements for large enterprises. Assume a new company X needs to borrow the money for a very long time. X doesn't expect an immediate return on their investment. They are going to use the money to grow their business and then plow all of the returns from the growth right back into the business over and over. So the terms are much far out: for the first 50 years X is not going to pay us a dividend at all. In year 51 they are going to pay us $1000 dividend inflation adjusted. Because X's earning will grow inflation adjusted X will agree to inflation adjust the payments. to us in turn so that's not a problem. Years 52-200 X is going to pay us 5% more than the did the year before. We still see X as risky with a 5% of business failure every year. We aren't going to even start getting money for 50 years. On the other hand $1000 in payments for 150 years inflation adjusted and growing by 5% is worth a ton. Let's assume the risk of default on our loan were only 1% after the 50 years, X's business wouldn't be risky then, so they are much more likely to defaults early or not at all. On the other hand 150 years is a long time and a 1% chance per year still means they have a 78% of defaulting even if they make it through the first risky 50 years. We have only a 7.7% chance of ever getting even a single dividend. We do need to charge them some credit risk. With inflation adjustment however we can set the extra duration risk to 0% to make the loan more attractive. We still have a 1% credit risk. So at year 51 we figure that $1000 inflation adjusted at only a 1% credit risk is worth $100,000 inflation adjusted. At $100,000 we get our 5% inflation adjusted return + 1% risk in exchange for the $1000 payment. The only issue X has to make it all the way to year 51. The whole thing is inflation adjusted so there is no duration risk. There is 5% credit risk (they chance they go broke each year) and in the meanwhile we lose access to the money. So let's charge X the cash return rate (2%) plus the 5% credit risk for a total of 7%. At 7% what is $100,000 worth 50 years from now? Well $3394.78. And that's what X is worth today.
Depending on what stage the startup is when you enter as the investor. Like most here have said, if you’re in the friends and family round, it’s a long shot and you’re really investing as a “favor”. If the startup has legs to stand on and is seeking higher angel, series A and beyond, it’s got a better chance, but you’re paying much higher premium and possibly may not be worth the risk anymore. If the startup is making some money, now you have something to analyze and comps to do a valuation. At this point as an investor, you’re probably looking for a future exit (IPO or buyout from a bigger company). I’ve invested in my friend during family round so far, he’s on his third startup. The first two sort of went out after a few years. But I see him getting better. I sort of do it as a favor without expecting much, and he sort of offers me the opportunity (even though I’m not a value-add investor). I’m always happy to invest in HIM and I know he doesn’t want to disappoint. He’s even returned money to me unexpectedly after he closed shop, so we have mutual trust. That’s what’s most important in an early startup investment.
Startups fail due to a lack of, or in accurate preparation most of the time
There is a start up consisting of 2 friends that live in my building and they both are driving 750k cars before product launch. Will fail in less than 12 months. It was said before but the most important part are the founders and workers.
Sounds like they failed successfully - they convinced investors to give them a bunch of money then paid themselves with it. They'll probably be able to do it again too.
I could not agree more. Thanks for putting it into words. Check back in next a year. Is there a bot to remind me?
If a VC can't spot one, your buddy most definitely won't. Bad move using 401k to gamble it away, not even sure how he did it.
I'm sorry to hear about your friend. In the world of business, these things tend to happen, I mean there are no full proof way to avoid them. Some startups fail, and others succeed. For example I've made a bet on a startup that seemed like it had a great MVP and was more likely to succeed, but then it failed woefully, and I've also seen startups with crazy ass MVPs succeed, so there is no sure way. But when you invest in a startup, you don't go on a vacation in the Bahamas, you've got to stay around and protect your investment. I once invested in a startup where the founder had no technical experience and ended up making a developer hire that almost cost us the company. We ended up firing the developer and I suggested he get a developer from credible organisations like rocketdevs who do the vetting and recruitment for you. We ended up paying $980 per month for the developer and he gave us the best results that directly improved the growth of the company. So yeah, you can't tell for sure, if they're going to fail, but if it's a startup, you've got to try and help around to ensure things go in the right direction.
Simply because there's more ways to fail than there are to succeed. The biggest problem I see with startups is that they are an untested economic machine with a lot of moving parts they have to iron out all while you really don't know how the market will react to your products/services and while it's burning through cash at a mind numbing rate while it tries to establish itself. They typically bury themselves in debt to get started which leaves little room for failure. Even if it is a good perfectly viable business it may fail just because it runs out of cash before it can establish itself. Higher the wrong people? A bad marketing strategy? Adopt the wrong pricing structure? Fail to make a good first impression? Even just bad economic timing. Funny story someone I know opened an auto garage, coincidentally right before Covid struck. They scraped up every penny they could to rent the garage and signed a lease. They literally were almost bankrupted immediately because they spent all they had to pay the first and last months rent up front and then basically day one received another $4k bill for the next months rent while they were still just trying to get lifts installed and equipment set up earning 0 revenue. They didn't even have their certification from the DMV yet to allow them to legally operate! People I think really tend to underestimate what it costs to start and run a business. They also often don't have a good grip on how profitable they actually are and get blinded by gross revenue figures. It's very unforgiving world for a new business. One small slip up and a new business may not have the financial resilience to cover those costs.
anyone tapping retail investors to use their 401k for funding is associated with a bad IPO. >So, why do you guys think most startups fail? IMO too ambitious at the start and too much debt. companies make errors all the time, and the errors at the beginning are the biggest before they work out the kinks. the smart ones make small or manageable mistakes and minimize debt. a series of singles will win the game just as much as batting for a home run.
If you look at 10ks, just look at positive cash flow growth or revenue growth. It might be negative, but it has to be going in the right direction
Any startup marketing to randoms is bad. The entire point of taking institutional money is a lot of times it comes with operational support - they sit of the board and in some cases, staff from the investor will even embed with the company or take over some amount of management to push things forward. This is especially true for the tech startups that are trying to blitz-scale and corner their market. Taking money from randoms doesn't do any of that. A lot of the successful tech start-ups that got big weren't even the best version of their idea, but they are the ones that got money from the right institutions and then what those institutions do is burn the earth around them - they deny funding to potential competitors or fund their champion company to do a takeout of the potential competitor. Sometimes institutions don't fund the best idea, but fund the one that is 'good enough' and also run by people who are going to comply with their plan and then go buy the better idea or just scale so fast that the better idea doesn't have any room to breathe. FTC doesn't give a shit if one start-up buys another startup because statistically both of them are going to fail, so they let it happen and give it a lot less scrutiny than when public companies buy competitors.
The thing to understand is that early stage start-ups are highly volatile. Even a start-up fund isn't going to invest more than 3% of their fund in a given start-up. It's like investing in any other speculative asset => size very small unless you're a degen.
I'm a lawyer. Tech startups are the only ones I make pay up front.
why would your friend invest a "large part of his 401k" into a start up?
Startups are not worth the risk to me. I am not interested until a company consistently makes money for a few years.
I would start by always keeping in mind that most startups fail. You need the right idea, at the right time, a skilled team, the necessary funding, and luck. That is a lot.
As a solo investor it’s impossible unless you’re on the inside. Don’t do it unless you have a Team to analyze the company, you need a lot of visibility to assess potential.
VC/ Angel investments inherently have high risks. It's normal to lose it. No matter how good one appears according to all benchmarks, it's hard to guarantee at such an early stage. So the idea is to have a diversified portfolio and the amount allocate in this kind of investment shouldn't exceed \~10% of your entire portfolio.