I recently invested a five digit sum and it turned out to be one of the worst deals I ever made. I'm not a classical investor or VC and currently I don't have a lot of money to invest, but I really want to learn how investors/VCs think and act. This would help to avoid investing hard-earned money in junk projects and also to learn how great business opportunities can be identified, whether that is in the startup scene or in other avenues. I want to learn the metrics of investing into businesses and how to separate "wheat from chaff". I realize this platform is more for helping entrepreneurs, but apparently there are some people in here who are both, i.e. entrepreneurs and investors. So what is the best way to learn the art of investing in businesses? How do you become an investor? How do investors spot and analyze business opportunities? Any tips? Any books or websites out there?
You’re asking some great questions, and beyond the fact that there is no teacher as great as experience, it seems tragic how common this experience is, and making great investments is hard even for seasoned professionals. But it’s incredible how often the only two factors used to assess an investment are how much it will make, and how much they like (or know) the people running the deal, when just a few additional questions can often make all the difference.
When looking at a new opportunity, the first thing I do is ask if I believe management’s story. This is really about getting a feel for whether you believe the people running the business or opportunity are qualified to exploit whatever inefficiency they have identified in the marketplace. If they can’t express in simple terms what that opportunity is, why they’re qualified to take advantage of it, and exactly how what they do will generate returns for the investor – run away. This is different than asking if I believe in the management, or like them – it’s about their ability to state in plain language their investment thesis, and back it up with the skills and tools needed to execute.
Next, put it in context - consider the size of the opportunity and this investment’s place in it. Is it a big market, or small? Lots of competition or not? Does this investment bring something new to the space and will gains come from new business or is the plan to take it from existing competitors? If there are no crisp answers to these sizing questions, consider it a big red flag.
The next bit is about understanding the risk of the investment. The single most common mistake made by investors is mis-pricing risk. Markets are pretty efficient, so there has to be a reason someone else isn’t already doing whatever this investment proposes to do and understanding what this dynamic is can be the single difference between good and bad investments. It may be that nobody has thought of it, or no one can do what this will do at the same low cost. Or there is an asymmetry of information, where you know something others in the market don’t yet know. Whatever it is, trying to understand the risk of the investment is key: understanding the timing of the probable returns, appreciating what could go wrong and how management will respond if it does, what change in the environment (like new laws, new competitors, new technology) could turn the deal on its head, and what assumptions need to remain true through the course of the investment. I’m not sure there is any way to get all of the right before making an investment, and surprises always happen, but the more work done to figure this part out can help determine whether the investment is worth making based on what its expected to return, and it often highlights something just plainly wrong with an investment.
Finally, know that there are very few great investment opportunities relative to the number of absolute junk stories out there, and finding ones that make sense for your risk tolerance and timeline just takes work. And experience. And even when you get everything right, sometimes good investments still go bad.
Your experience of making a bad investment decision isn't tragic in the VC world, it's the everyday reality. In order to generate stellar returns from one investment, VC's invest in several promising companies (proven market fit, good/coachable team, ideally in an industry where they know the space as well or better than the founders and have connections).
VC's also have the dry powder (money in the bank) to either sustain their investment with a bridge loan to another round or to maintain their ownership percentage via pro rata rights.
It sounds like you don't have the amount of money necessary to invest like a VC. Plus, if you're not accredited then you aren't supposed to be investing in that manner anyway. That's not the end of the story though because VC-style investments are only one path.
Other things to consider:
a) adjust what type of companies you're looking at. Home run types of companies that are basically a billion dollar lottery ticket have million-to-one odds. Consider turning singles into doubles by helping a small company that's got revenue and break even cash flow become a profitable company four times larger than it is now. Or consider the often maligned "lifestyle" business which can generate very nice cash flow and an exit (typically at much lower multiples).
b) use what you have that VCs don't - time. VC investors have timeframes to get a return, regular investor updates to make, and limited time to actually get involved in a business. Find a business you are excited about guiding and get hands on in an advisory role. If you can't figure out how your involvement will increase the company's revenues or profits by 20%, question why you're considering that investment.
c) To find good investments and to learn how investors think, get involved in the startup world. Mentor companies, become a judge for startup weekend and pitch competitions, etc. Exposing yourself to companies pitching and people judging (more experienced than you) will help you develop a deeper understanding of what professional investors are spotting so quickly when they reject an opportunity in front of them. It's in the process of mentoring that you develop relationships with founders, get to understand their business, potentially consult with them and then know without a doubt if you want equity in that company or not.
It's less glamorous and more time consuming to take this approach, but it leads to a high success vs. whiff rate.
You learned a very good lesson from getting burned. You learned what a bad business investment looks like. Go over why your first investment failed to learn what signs to look for when investing in the future.
You have to fine tune your b.s. meter. Unfortunately , this usually involves being burned at LEAST once.
Investing is gambling- do not invest more than you can afford to lose. It may be the next big thing or it may be a flop. Even if it is the next big thing, it could wind up a flop if people are idea plentiful but fiscally foolish.
Don't get emotionally invested in the project. Ask for a business plan. Does the person whose thing you are investing in have skin in the game, have they invested any of their own money in the project? Are they talking to other investors besides you?
Talk to outside people about the project ( don't get specific , but enough general details) to see how the purchasing public reacts- does it hold their interest or are they saying "meh...".
To be a successful investor you must be willing and able to assume and absorb financial risk. You have to have enough of an ear for what people really need/want that your gut says "yeah, this WOULD be a good investment" or "meh, not worth it".
Don't be demoralized by the first failure. Everything is a learning curve and now, in your brain are certain alarms that will sound if they happen again. Good luck !
I've successfully made dozens of private investments into small businesses since 2008 and have only had one go bad. It was a second-lien mortgage deal brought to me by a broker. In general, my deals yield me between 12 and 25% APY and always have multiple 'ways out' should they go bad.
Being an accredited investor is a legal definition. You don't apply for this or go to school to learn it. The definition can change by jurisdiction. Where I live, for instance, one can be considered accredited if total net worth is over $5M, If liquid investments are over $1M or if your income is over $350K/yr.
Basically, a farmer with no mortgage would be considered an accredited investor or perhaps a dentist who had a few associates.
The rules about accredited investors are there to keep guys like you from making the investment that you did.
The problem with most investments being pitched is that they are for equity in startups. This is the riskiest place to invest one's money. The large VC investors that you cite in your question typically make many investments knowing full well that most will go bust. Their business model relies on having just one or two shoot to the moon. You probably can't afford this.
I recommend you start with small secured loans to local real-world businesses. Get your feet wet and educate yourself with respect to how you can manage various downsides.
My book, Invest Local, is all about this. It's on Amazon or your can get it from www.InvestLocalBook.com
On that site you'll also find hundreds of blog posts and links to over a hundred videos on local investing. Once you're ready to act, I also recommend my online course which is at www.LocalInvestingCourse.com
If you want my help, schedule a call with me after you've read Invest Local. It's only $10 and sometimes Amazon has it on sale for Kindle.
Best of luck.
It is an extremely competitive field and it appears you are looking for substantial returns instead of modest success such as just keeping up with inflation. To succeed at getting high returns, a blanket piece of advice is that you have to be more knowledgeable than the vast majority of people investing in a given arena. For example if you are investing in tech startups you would probably need many years of experience and success in analyzing and/or starting tech companies. It is probably best to start with low expectations and gradually build knowledge for over a decade in your market before taking on more aggressive investments. Investing is no more of a road to easy money than any other field.