An expert YPO investor’s best advice: “Don’t follow the herd.”
Starting a business or investing in a startup is not for the weak. The statistics are daunting, ultimately 95% of startups fail. One in five startups will fail in their first year, according to National Business Capital & Services, Inc.
With these odds, it’s amazing how many businesses are launched every year, and with economic conditions improving, the number of startups hitting the market will only increase.
Mariano Gonzalez, a YPO member and an adviser with Emergent Ventures, lays out clear-cut rules for first-time startup investors. After being in mergers and acquisitions for over 10 years and becoming a Sloan Fellow at London Business School, where he studied industry structures and growth strategies, Gonzalez is directing his energy toward the impact and Environmental, Social and Corporate Governance (ESG) investing field.
“Don’t follow the herd, and don’t get into things you can’t get your hands around. Your first startup investment should be in a business you can explain to other people, especially if it involves an ESG or impact strategy.
What turns off investors from startup, ESG and sustainable investments
Let’s start by addressing three often-mentioned factors.
The first one is that many investors believe that profit and purpose cannot coexist. They absolutely do go together and create value, he says.
“There is plenty of research supporting the conclusion that over the past 10 years, companies with ESG strategies have outperformed their non-ESG peers, resulting in higher valuations and the consistent generation of alpha for investors,” Gonzalez says. It is no surprise that assets under management (AUM) in this field now stand at over USD30 trillion or 30% of global AUM.
A second factor that drives investors away is the perception — before any analysis — that the investment is risky simply because it involves something new. This creates either an automatic dismissal of the opportunity or a sense that the return must simply be astronomical to compensate for this perceived extra risk.
A good way to beat this bias is by challenging your beliefs and by going back to basics in your due diligence. Not everyone has the same information; the startup is passionate about their innovation; you might have never heard of it. It’s natural to be skeptical.
So, put aside the innovation for a second and ask the startup: What problem are you trying to solve? What does the market you are going into look like? How are you going to compete? If you can get your hands around this, it will be easier to understand why the proposed innovation or business model is designed the way it is and why it may (or may not) succeed.
To Gonzalez, this is precisely one of the biggest opportunities for a startup investor. Spend less time trying to become an expert in the innovation and spend more time understanding the industry structure and how the company intends to be successful.
If you do the above, and you are looking at an ESG situation, you may come to the conclusion that the proposed ESG strategy/innovation is actually helpful to mitigate operational, financial, legal or other risks initially perceived. A plastic company seeking to launch a product that is reusable or compostable may very well have a lower level of risk, all else held equal.
Perhaps a third turnoff is that many startups tend to overestimate the quickness with which their innovation will be adopted. It is important to learn from management how long they will experiment with one territory or client or product before they scale. What gates must they cross?
Even large investors can get it wrong sometimes
Today, home delivery is as ubiquitous as a Post-it note. Everyone seems to offer it and a growing number of operators seem to cover every neighborhood with increasing efficiency.
Nevertheless, 20 years ago, Webvan, after raising more than USD1 billion in cash, went bust in spectacular fashion. The case has been widely dissected and many reasons have been proposed for its failure.
— Mariano Gonzalez, Adviser with Emergent Ventures share
Two of the most often cited reasons were precisely understanding the industry and assessing how quickly people would adopt the new service. Many analysts point toward the incredibly thin margins of the grocery business and wonder how it could be possible to provide further discounts, add the cost of delivery and the logistics infrastructure and still make a profit. Ultimately that proved impossible. Further, the incredibly rapid expansion (and cash burn) of the company to cities across the U.S. overestimated significantly the rate of adoption of home delivery. The company’s push to open in other cities while penetration in existing ones was completely below expectations was questioned by noting that it might have been better to focus and succeed in a limited market before reaching for wider scale.
What to look for in a startup investment
Take note of these pointers to improve your odds of success as a first-time startup investor:
- Your first filter should not be “everyone is getting in on this.” Do not fall prey to what’s hot or invest because XYZ person is investing or because people say the return will be huge. If these factors drive your investment, you will be disappointed.
- Invest in what you know. You must understand the business. If this is your first investment, do not start with something incredibly complex that you can’t understand or explain to other people. If you are close to or in the industry where the startup intends to operate, you will much more quickly and easily understand the challenges the company will face.
- Look for a team open to a partnership with you. If you invest in what you know, you will also more easily find a situation where, you can play a role beyond that of a check writer and add value to the company and your investment. This can be a great learning opportunity. Perhaps you can become an adviser. Stay in touch and offer to help and provide some leads.
The next two years will be busier than ever for startup investing, and great opportunities to deploy capital in every sector imaginable will be available. While investing in startups is risky regardless of sector, by starting close to home and devoting more time to the market, its dynamics and how the company plans to create and capture value, you will get to know the company and the team much more intimately and be able to make a more informed decision about going forward with your investment.
Passionate about mentoring business startups, Gonzalez works with a group of seasoned CEOs working in partnership with early-stage XPRIZE Foundation entrepreneurs to help them grow their disruptive technologies to scale in order to positively impact millions of people all over the globe. Last year, Gonzalez began working with San Diego-based Learning Upgrade CEO Vinod Lobo, who won USD2.5 million from the Barbara Bush Foundation Adult Literacy XPRIZE in 2019 to develop a mobile literacy app and has helped them establish a goal and plan for reaching 100 million new learners over the next decade. Learning Upgrade was recently used as a success case study that Elon Musk studied ahead of his USD100 million funding of the XPRIZE Carbon Removal.
XPRIZE is a global future-positive movement of 1 million people and rising. As a 501(c)3, XPRIZE delivers truly radical breakthroughs for the benefit of humanity and solves some of the world’s greatest challenges. Join XPRIZE to help create a better future for everyone, everywhere. To find out more visit xprize.org.
