Last night, I asked the crowd on Twitter what they’d like to hear about in today’s column. Entrepreneur John Petersen wrote back asking questions about what it’s like to get into early-stage investing, as more people want to get into the game on some level (and I believe they will, particularly if there are more liquidity options available in the future).
Regarding my own investing experience, I’m making it up as I go along, but here’s what I believe someone has to think through before diving into this kind of investing:
First, is the person able and willing to see an investment nosedive to zero? There are reasons that regulations require that potential investors have a certain level of income before investing like this. It’s hard to get money back from early-stage investments, and even if money does come back, it may take a long, long time. This is obvious to most, but not all — so it bears repeating.
Second, assuming a person is able to lose the money earmarked for investing, does that person want to invest directly into startups or as a limited partner via someone else’s fund, or start a fund (or a syndicate)?
Option 1: Direct investing may appear to be the most fun, but it’s hard to gain direct access to these early-stage opportunities, and founders are savvy, seeking to partner with people who can help them. It’s also possible to use AngelList or other crowdfunding platforms to directly invest, but often there’s a charge on carry associated with it, and not everyone is allowed into each syndicate to which they apply.
Option 2: Many others put their money to work by investing in a fund that will deploy that money across a portfolio, spreading out their risk. Generally, the individual LP pays the fund a fee to invest the money but stays at arm’s length. In some situations, though, LPs will strike agreements with a fund’s GPs to co-invest alongside them and pay a bit in that carry but save on fees. This sounds good in theory but often in the most competitive deals, even the GPs are fighting for their allocations. (AngelList has also started to create industry-specific syndicate funds that investors can back, in addition to applying to back other funds on the platform.)
Option 3: Creating a new fund is a third option. It’s costly and time-consuming, though, requiring intricate tax and accounting setup, fundraising activities to recruit LPs, and a strategy to deploy and manage the funds invested.
Option 4: Creating an AngelList syndicate is a bit easier but not easy, either. Typically, the individual needs to be investing his or her own funds, building a syndicate against his/her reputation, and then harnessing the syndicate to move in step with each check, enjoying financial leverage with carry along the way.
So much of investing depends on the individual, including how much access they have to great founders and how much they want to work to find investments and manage money (and relationships). But for those who are really serious about the topic, it’s worth reading, and bookmarking, and reading again this short but insightful 2012 post by Andy Rachleff, who cofounded both Benchmark and Wealthfront and teaches at the Stanford Graduate School of Business. Today, I tried to lay out some options for folks who are interested in dabbling; in Andy’s post, he soberly tells it like it really is based on years of experience. It is required reading.