Early stage investing 101: How to break into the club, and why you should give it a shot
- Start Ups & Companies
Early stage investing can be tremendously beneficial for early stage technology companies, the broader startup ecosystem, and of course,
Early stage investing can be tremendously beneficial for early stage technology companies, the broader startup ecosystem, and of course, investors. But getting started isn’t easy.
We both know this first-hand, having overcome obstacles to become investors ourselves. We know many people who are in similar situations but haven’t yet taken the same leap. We see three primary reasons that people don’t get into investing.
- The financial community (wealth advisors, brokers, etc.) tends to be old school, and has historically thought of early stage private company investing as too risky and unnecessary to achieve sufficient returns as part of a broader asset allocation strategy.
- Potential investors have failed to recognize the indirect benefits of early stage investing.
- As a community, we’ve done a crappy job of providing transparent and accessible onramps into early stage investing. It has been too much of a club.
We believe that early stage technology investing, especially in geographies like the Pacific Northwest, is still at the beginning of its history of creating wealth and great new companies. A lot of money has been made by investors in existing technology companies. We believe that there’s even more to be made in the future. We want to be sure that you have an opportunity to make that money.
Here’s our “insider” take on why and how to become an investor.
The case for early stage investing
Marc Andreessen, one of the most prominent technologists, founders, and investors of our time, started beating the drum over a decade ago that the public markets were losing out increasingly in the value creation stage of tech (and therefore most high growth) companies. His concern was that inequality in society was being increased by the fact that most people invest through 401Ks and similar vehicles that are limited to the public markets and that companies no longer go public until most of their value had been achieved. For example, in contrast to Amazon and Microsoft, who went public at a valuations 1000x less than their value today, Facebook, Twitter and Snap went public at valuations at most 10x less than their value today.
This trend appears here to stay, as it is harder and harder to be a public company, and late stage private money is plentiful and valuations generous compared to the public markets (notwithstanding Softbank’s troubles and some anticipated adjustment to private market valuations). So, strictly from an asset allocation perspective, failing to have early stage private company exposure looks increasingly questionable.
And there’s more financial goodness to be gained by early stage investing than the asset allocation benefit: access, network, and knowledge. Rightly or wrongly, being known as an investor in a community is one of the most status enhancing qualities we know and will give you access to venues, people and opportunities that you would not otherwise have. Even if you have achieved everything you want in the world and don’t care about any of this, it can be beneficial to your family, your friends and people you generally want to help. And, if you are a woman or an underrepresented minority, this is underscored for you because you need (like us) all the credibility enhancers you can get.
As an investor, you will also be part of a network with other investors who keep up with what’s happening on the cutting edge of technology, society, and capital. If you are investing directly in companies, want to start your own, or help an entrepreneur, your network will be invaluable, since the greatest risk to all early stage companies is a lack of follow-on financing. These other investors, and the teams at the companies you invest in, are some of the most interested and interesting people in the world.
We all know the adage,“who you know is as important as what you know,” but who you know also dictates what you know. And, with your capital invested, you have both access and motivation to keep on the cutting edge yourself. Working collaboratively with founders and investors to discover, examine, fund and support early companies builds new knowledge that will be helpful in your day job and expand your professional capabilities. Bonus points if you have a particular mission in life (environment, underrepresented founders, international development, for instance) because you can surround yourself with likeminded people and opportunities by targeting investments to that mission.
If you are lucky to be located in a tech rich geography such as Seattle, all of these arguments are doubly strong, because local relationships are even more important for successful networks, whether for you individually or for the companies and funds you invest in. And, if that region happens to have an underdeveloped capital market, high five, because now you have less competition to get into the best deals. Read the excellent analysis by Oren Etzioni and Jacob Colker of the Allen Institute for Artificial Intelligence to understand why that’s true for Seattle. As Seattle comes into its own as technology superpower, all of us who can will want to invest like we are one.
How to get started
So maybe at this point you are thinking hey, I should look into this, either for now or for when you have enough saved up so this is realistic!
Regardless, it’s on us to make that easy. Not all of us have the opportunity to invest alongside Marc Andreessen, but thousands of you reading this qualify as accredited investors today (or will someday) and could meaningfully participate as early investors in the next big thing. Here’s how:
Start by learning your investor accreditation status. Legally, individuals meeting this threshold can participate in direct (angel) investing and indirect (fund) investments. For a full run-down, check out the investor education information at the SEC website. Typically, individuals are accredited if they earn $200,000 a year (or $300,000 with a spouse) or have a net worth of $1 million (not including your primary residence).
Next, take a look at your investments, and do some quick math for asset allocation. You’re probably familiar with that concept when it comes to public equities and bonds, the idea is that you should distribute your investable assets across multiple categories with different risk and return profiles. Very simplistically, you’ll sometimes be advised to allocate 60 percent stock and 40 percent bonds, for example, and it gets more granular from there — international equities, commodities, real estate funds, etc.
Higher return assets typically have higher risk, so you want to balance your portfolio with less risky (and less return yielding assets) — in this example, bonds being the lower return/lower risk asset. And, you need to think about diversification in each asset class. If you hold a lot of Microsoft or Amazon stock as a result of working there, you probably have had a financial advisor urge you to “diversify” by selling some of that stock and buying other proxies for large U.S. public equities even if your asset allocation is otherwise perfect.
Needless to say, early stage equity investments fall into the very high risk category. So, you want to allocate only a small portion of your equity allocation to them. And, you want to be diversified among more than one or two startups. The consistent advice we’ve heard is that allocating 5-to-10 percent of your portfolio and making 20 different investments over a number of years (directly or indirectly) is the right way to do it. Here’s a study that’s helpful.
As we’ve both approached our investing, we’ve considered the other benefits that we receive (outlined above) in addition to the direct returns to help cushion the risk. We also think about our other streams of income and how our day jobs fit with our investment strategy. If your day job is at a small company where you hold significant stock and make a lower salary, you’ve in effect already made an early stage investment, so you might allocate less to other early stage opportunities. If you work for a large company (or your partner does), you might want to allocate more. Finally, we’ve both found that we tend to be more conservative in our main asset allocation (weighting more to bonds so that we can take more risk in private equities, not public equities).
Finally, don’t forget about liquidity. Unlike public equities, and more like real estate, you can’t get your money out of early stage stage companies on a time frame that you choose. Plan on waiting at least five years to see any of your principal coming back to you.
The key is to find a way to do this within your budget and time frame for liquidity needs. We’ll describe below some options in our backyard (Seattle) for different budget sizes (and time commitments!). You can do it as a near full-time job and invest directly (roughly $500,000 commitment over 4-to-5 years, yielding a 20 company portfolio). Or you can do it as part of an angel syndicate that allows smaller checks (roughly $100,000 commitment over 4-to-5 years and a fair amount of time) or you can invest in a venture fund (often $250,000 commitment over 3-to-4 years and no or flexible time, depending on your skill set and desires).
A primer on angel organizations
So, with your rough math in mind, start connecting with others in your town to learn more and get involved. And keep in mind that you’ll be investing over the course of several years, not all at once.
As an example, here’s what we can tell you about Seattle investing groups and funds.
Angel groups in Seattle
Each angel group has its own format and membership process. For learning, Seattle Angel Conference is popular because it offers a small investment commitment and a lot of hands-on experience. Alliance of Angels is a longstanding angel network with its own seed stage fund for making investments in addition to direct investment opportunities. Others specialize — for example, E8 Angels focuses entirely on clean technology and sustainability investments.
- Alliance of Angels: Angel group with more than 140 members where individual angel investments are augmented by a $6.6 million seed fund. Membership Fee: $2,250 the first year, then $1,750 annually. Seed fund investment opportunity also available.
- E8 Angels: Focused exclusively on early stage cleantech and sustainability investments. Membership fee: $1,000, annually.
- Grubstakes: A volunteer-run group of actively investing angels. Membership fee: $0
- Keiretsu Forum Northwest: A worldwide investor network with local chapters. Membership fee: $475 initial fee; $3,000 annually
- Puget Sound Venture Club: Limited to 35 angel investors at any one time. Membership fee: $600 annually
- Seattle Angel Conference: A learn-by-doing “accelerator” for angels. Funds are pooled to invest $100,000 to $200,000 in two or more companies per year. Minimum investment: $5,500, per series.
- Tie Angels Group Seattle (TAGS): Investing in business-to-business seed stage ventures, as part of a national chapter network. Membership fee: $500, annually.
Nationally, the non-profit Angel Capital Association provides educational resources, seminars and conferences.
Early stage venture funds in Seattle
These professionally managed funds invest in early stage startups and accept individual limited partner investors (“LPs”) into their venture funds. A common minimum commitment is $250,000 (spread over 3 or 4 years). Funds charge a fee (typically 2 percent) to manage your money and share the upside with their LPs (typically on an 80/20 basis).
Funds are a path to gain insider access to venture networks, diversify your startup investment portfolio, and get access to deal flow at the venture stage or that bypasses angel investors. A fine point, but an important one, is that if you are an angel, being part of a fund can increase your chances of helping your angel portfolios get follow on financing, and mitigate one of the worst risks of early stage startups.
As a venture fund investor, you entrust the fund managers to source deals and build a portfolio of investments. Fund managers provide regular portfolio company updates and report fund performance for the life of the fund, often around ten years. Fund managers may also host private events, share their perspectives and analysis on an area of the market, among other touchpoints. Here’s a list of early stage funds based in Seattle that may take commitments from individuals:
- Acequia Capital
- Ascend Venture Capital
- Cascade Seed Fund
- Flying Fish Partners
- Founder’s Co-op
- Illuminate Ventures
- Pioneer Square Labs Ventures
- SeaChange Fund
- Seven Peaks Ventures
- SWAN Venture Fund
- Unlock Venture Partners
And, look for new funds to emerge to (literally) capitalize on the venture funding gap for early stage companies in the Pacific Northwest. These emerging fund managers see a market opportunity — one we hope you see, too.
Heather Redman is the co-founder and managing director of Flying Fish Partners, an early stage venture capital firm investing in AI, and chairs the Washington Technology Industry Association as well as serving on several boards. Her prior experience includes active angel investing and senior operating roles at companies large and small.
Minda Bruse has been active in the Grubstakes angel investing group and served as Fund Manager for Seattle Angel Conference XVI. She recently co-founded First Row Partners, an early stage venture capital firm. Prior to her investing roles, Minda held leadership and co-founding roles at various startups.