Investing in startups VS public markets?
Decision framework for investing in startups, through the lens of a public markets' investor
Investing in equities is risky, but in startups is riskier. Equities are liquid with achievable returns (mostly), startup investments are usually considered write-offs. I’ve often thought about why I should allocate any money to startups if most VC funds deliver 15-20% IRR or lesser, which I’m already able to achieve (and during some good years surpass) with my investments in Equities.
3 reasons why I do it (and it’s not money)
Learning: The world is evolving faster than ever, and startups are creating and enabling the future that we’ll live in. Being able to learn through deal memos/monthly updates, interactions with 100s of founders in a year, getting insights across different industries that I may be interested in but won’t build in are some of the underlying motivations. In fact, most of my startup investments have been businesses that I really wanted to exist or thought about multiple times & then ended up finding a solid team that was building it.
Network: I truly believe that entrepreneurs are some of the best minds out there, fighting their own minds and the world to make something worthwhile. When they’re wrong they’re called crazy, but when they’re right, everybody wants to be like them. You need to have a very stoic mind to be able to deal with the highs and lows of this journey. I respect the hustle, I respect the desire to create & want to surround myself with a bunch of people working on amazing products and ideas, who wish to change the world.
Compounding: Laws of compounding work beautifully in relationships, in business & investing. The more I can find and work with people I trust and respect, the easier it becomes for me to build businesses and make investments. I made my first investment at the age of 24 & while that startup failed - it taught me more than most other experiences have. Since then not only my portfolio of investments has grown, but also the quality of relationships with people I started working with through them.
Decision framework of startup investments
Almost all of my startup bets have been at the seed, pre-series A stage. The lens that I use for these investments is 1) Founder market fit, 2) Large market size & 3) Fanatic reviews of ‘a good tech product’ by users/customers.
The charisma of serial entrepreneurs & founder market fit
Investing in startups, especially in the pre-seed or seed rounds, you don’t really have data as you do for stock markets such as annual reports, analysts’ ratings, technical analysis, and so on. Sometimes your bets are pre-product or pre-revenue as well. What I do believe in, and has fortunately proven right multiple times now, the pull of second or third-time entrepreneurs AKA serial entrepreneurs. This bias might stem from the fact that I had to build several businesses before I learned the rules of ‘the trade’.
Entrepreneurship is all about selling. Selling to investors, early employees, customers, and as a first-time entrepreneur, you make many costly mistakes. There is something known as a ‘hypercorrection effect’, which basically means that the learning you derive from the errors you make with high conviction is more likely to last a long time. Second or third-time entrepreneurs have hopefully learned from their past mistakes, and know the common traps that most first-time entrepreneurs get caught up in, so their ventures tend to deliver higher ROI. This extends to the theory of founder-market fit wherein the entrepreneur must have domain expertise (not years of experience, but the quality of depth & insights into the industry) and/or unique customer insights (early user feedback and validation is key) for the sector they’re going to build in.
Working backward to assess true market size for sectors through public markets
Through public markets, though you can derive a deep understanding of how India truly operates, and how large the market size of a sector really is, and that influences my decisions of investing in startups as well. For example, close to 50% of India’s stock market (which is roughly $2.2 Trillion USD) is driven by financial services and hence you see why fintech as a sector for startups has seen the significant amount of funding that it has.
Another reality of the Indian market is that “only around 1.46 crore individual taxpayers are liable to pay income tax. Further, around 1 crore individuals disclosed income between Rs. 5-10 lakh and only 46 lakh individual taxpayers have disclosed income above Rs.10 lakh”. Knowing this, you realize that the paying capacity in India is restricted to a very small group of people & you can make informed decisions when you invest in startups depending on which market they want to serve.
A superior product with fanatic reviews/love from customers/users
Early product validation by customers and users often signals better compared to all the vanity metrics (valuation, round size, co-investors etc). If you are irreplaceable or deeply loved by users and they can’t do without you, you won’t really need to ‘sell’ too much to investors. In public markets, this would equate to an Asian Paints or HDFC Bank where the customers and retailers have so much trust in these franchises and brands that it becomes a MOAT for these listed companies, and btw these two stocks leverage technology much better than their peers in the market!
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