What startup companies should you invest in? In a world of toxic positivity and snowflakes where everyone is telling everyone they are amazing, some companies will end up faring better than others. And consequently, your bank account will do better in some cases than others. This goes for not just investing in startups, but stocks, commodities, crypto, real estate, etc.

So which investment ideas will pan out, and more importantly, which ones won’t so you can avoid those disasters? Does originality or first mover advantage matter? Does credentials, educational background matter? How about previous startup experience or other corporate experience? How about the valuation? What about the founder, does is there anything to distinguish?

Superior product

Is the product better, faster, cheaper, differentiated in any way? Does it reinvent something existing better? Does it create a product category of its own, serving an untapped niche? Or better yet, an untapped need that many people face? Uber is not necessarily the most inventive idea, given the taxi industry already existed. But they did not have a convenient service that took into account the smartphone evolution. And Uber capitalized by having much greater supply in drivers, and with a mobile app to allow a Uber to arrive in a matter of minutes in some cases, they ended up offering a better product on top of what already existed, and now in many markets it operates, as the top or 2nd positioned company in the space.

Etsy served a relatively untapped niche in the ecommerce space with handmade, crafts and other vintage items. These offered superior quality and selection options that amazon did not have, thus carving out its own successful spot in the ecommerce realm.

Food delivery companies capitalized on the lack of delivery options for food and effectively created a new market. Granted, these companies have a challenge in becoming profitable, but early seed or series investors have made an absolutely killing in these companies. Companies with explosive growth tend to have good products, particularly if it is sustainable.

On the other side of the coin is the many failed companies and products that have been tried. The newest beverage company trying to compete with the likes of coke or its affiliated brands. A company trying to take on existing ice cream options, granola bars, or any other saturated market where the different is determined solely on price; these products and companies tend to struggle for profit and end up going away quietly in a red ocean of bleeding money and competition.

Market size

The bigger the better. In this case, this refers to the TAM, total addressable market. This is the total possible market for the product. Then within that is the SAM, serviceable available market. This is the portion of the market that a company can acquired based on the business model. Within that is the SOM, the serviceable addressable market. That is the % of the SAM that can realistically be captured. Companies that can obtain a large market position in a large market will stand to do better than companies that obtain a large market position in a narrow niche. Apple may be one of the few companies that could make it to the 22nd century, with every person in the world seemingly needing an iPhone, iPad, Macbook, headphones, etc. Contrast that to a public phone charging station that costs money to charge and hold the phone safely in. Now, phones have much longer lasting batteries, and there are charging outlets everywhere. In addition to portable chargers that can be brought on the go. One qualm to that is big markets tend to attract more fierce competition, so winning large markets is far more difficult. Whereas niche markets have less competition, so companies in those industries could be seen to have a higher chance of success, albeit with a lower return as a market leader. Personally I prefer companies that are going to succeed, regardless of the market, and then look at the market as a secondary piece.

First mover advantage

In many ways, first movers get an advantage. They hit a new blue ocean category with no competitors, and can thus afford to make mistakes without risk of losing customers to a competitor. They are able to even dictate to some extent, the landscape of said market. This is evident in the new cloud world, particularly on the corporate side. Amazon Web Services, AWS, had a 7 year advantage over all its competitors. That turned out to be an advantage too great to overcome, and now are the #1 cloud provider ahead of Microsoft Azure and Google Cloud. One could make the case too with Tesla in the US and BYD in China for electric cars; they were well ahead of the curve, and by the time the market appetite for electric cars gained steam, they were in great position to capitalize.

In other sectors, we see the big winners were not actually the first movers. Google was reportedly the 10th or 12th search engine to show up, with other market incumbents having already existed. And yet today, Google has a monopoly on the search engine market, although ChatGPT may have something to say about that in the future. Facebook came alive after myspace, skype messenger were already popular. Many other options for email had already existed before Hotmail, but now Hotmail is one of the top players in terms of email. It appears in the short-term, first movers have advantage in who to hire, jumpstart in data on the market, raising money, etc. If competitors move more effectively, then in the long-run it is meaningless. Iterative 2nd, 3rd, 4th, etc companies in an industry often ends up with the lions share of the market. Whichever company can first become the dominant market player, they end up achieving superior margins for as long as the brand sustains superior positioning.

Founder

Many of the top investors look at the founder and the quality of the founder as the most important determinant, given the lack of information or proof elsewhere. Qualities to have and not have. Ambition, mission focused, character, integrity, intelligence, energy, temperament, vision, execution, culture, technical expertise, strong strengths, perhaps an eccentric genius. On the other hand, some founders are madmen, crazy, arrogant, delusional, disingenuous, bragging, all words and no actions or results, respond badly to critique or advice, lacking integrity, disrespectful, doing it for the money only.

Sometimes it can be very hard to distinguish. Some of the best founders see a truth and vision that no one else can, and are stubbornly passionate, even to the point of telling the VCs they pitch to why they are right and will change the world. I guess reading people themselves and finding those outliers to some extent requires the person themselves to have those outlier qualities to be able to recognize them in others.

Some stories have investors sit down with a founder and within minutes they have already decided to invest, without even knowing the full plan or pitch. And they ended up being completely right. Case in point Masayoshi Son investing in Alibaba in under 5 minutes after meeting Jack Ma. And doing so on the hunch of reading his eyes. Wow.

Other criteria that certainly help would include founders with a previous track record of success. For instance, someone who has had one or more exits from past companies that they co created. And degrees continue to offer a signalling status, so Ivy League background educations would figure to indicate future skill, albeit not necessarily correlated. Other early successes could also help, such as creating a web browser plugin with 20 million installs, success as a product manager in introducing several small useful products. Those early unusual successes tend to lead to increased skill and opportunities in the long-run.

I’d wager if someone like Elon Musk decided to start a new company and make the seed round of the company available to equity crowdfunding, even without deciding what the company or product is, would likely be oversubscribed and have too much money to play with. Or Evan Williams, founder of blogger, twitter and medium. And many other examples of someone who has had multiple founding successes, blind cheque money will easily flow towards them.

On the other hand, scams like Theranos and FTX serve cautionary tales that despite a founders credentials, supposed progress, connections, and high educational backgrounds, a lack of integrity and character will lead to a smart crook taking the money for themselves, leaving investors in a long messy battle to try and recoup any money back.

Valuation

Valuations tend to be lower in recessionary times, and higher during booming times. Certain sectors may also be more likely to command a premium, such as tech-based industries or the hot industries that are trending at that point in time. So sometimes in booming times, some companies in some industries may be raising money at 50 times sales, or even entirely pre-revenue. Other times when money is difficult to come by, those same companies could be raising at valuations at just a few times sales. What a drastic change with the same companies, just depending on the timing of the market itself.

When looking back in hindsight, great investments that panned out seemed cheap at the time (regardless of valuation), and bad investments seemed too expensive at the time (regardless of valuation). Imagine getting into a seed round or Series A for Stripe. Stripe’s peak valuation in 2021 was nearly $100 billion USD at $95 billion, while in 2023, it raised a new round at a valuation of $50 billion. At it’s a seed round in 2021 when it raised 2 million at a valuation of $20 million, did it really matter if the valuation was 10 times sales, 50 times sales, 100 times sales? It’s now up 2500 times in 12 years.

On the other end, once promising startups that now went defunct, not sure if anyone cares what the valuation was when they invested. Juicero in 2017 raised $120m, trying to sell $400 machines to generate a juice squeezed machine. The founder, Doug Evans, self proclaimed and compared himself to Steve Jobs, and bragged openly about the machine and the packets of fruit it sold. The only issue was that a human could end up squeezing the packets effectively than the machine. The company shut down after only 16 months. I guess you can say they raised money well, but had no execution at all. Ouch. No mentions of the valuation being “too high” or “too low” at the time, instead looking at the business failure overall.

Team

The team matters, as they are the builders who will determine if the company succeeds or fails in many cases. Psychologically, high quality people tend to attract high quality people and want to be around other high-quality people. A mediocre founder, with less than stellar character may not attract the greatest builders, engineers, sales, marketing, and end up failing. Usually the first few hires, if they are not sound hires, will sink the company. Founders in some cases spend even up to 1/3 of the time finding the right people to hire in all capacities, whether through LinkedIn, tapping into existing networks, or through VCs with board seats that contributed in early rounds. The early employees are the anchors of a team; should they falter, the entire enterprise will slowly collapse.

Is the team committed to the goal, or are they temporary hired mercenaries who will leave at the drop of more compensation? Is the compensation fair and incentivizing them to think like owners with aligned incentives?

Cash: runway, ability to raise future capital rounds

Cash to startups is the same as oxygen to people, given the loss nature. Too little cash, and the whole company is at risk. Too much cash, and complacency could arise. Additionally, raising too much money in early rounds could lead to too much equity being given away, potentially limiting the ability to raise cash in the future or to compensate people appropriately. Many VCs and angel investors suggest an amount that can lead to a runway of 12–18 months, before then deciding if more should be raised. Successful branding leads to an easier time to raise money and more money in the future, and this brand recognition could make or break a company.

Network

There’s an old adage that goes, it’s not what you know, but who you know. Fair or not, having access to higher quality deal flow, or perhaps the best deal flow, on average is going to yield much higher returns. If I can see the next big thing coming that I use in a regular basis, that doesn’t mean anything if I don’t have access to said deal. Hence why people flock to Silicon Valley in hopes of “networking” the way to one of these life changing companies. If facing this location deficit, another option is to tap into local markets in person. But, it is unlikely to generate the same returns, given the filter of location restriction with no apparent upside. The other option is to look at various syndicates, paying a small carry and management fee for the chance to have the best manage your money. Although, this requires net worth and minimum investment values and are often near or at accredited investor level aka millionaires. So, a strong network may not be feasible for the average joe. A poor man’s method could also involve investing alongside the best investors from investments that are available to non-accredited investors, just at later rounds and higher valuations.

Investors

Piggybacking off of successful angel investors, venture capitalists, syndicates, and tier 1 firms by cloning the investments they make is also a decent strategy. This would acquire the batting average of said investors, and if they had a strong track record, copying enough could lead to similar returns. Of course, a few isolated incidents will not lead to a mirrored return, given the sheer quantity of investments made by the firms. Investing in startups that the top investors invest in after you frequently may also be a sign of confirmation that the judgment process is similarly aligned to the top investors. Another way to look at it too is to ponder over what the top investors would invest in, and then invest in those companies before they do at cheaper valuations.

Wow factor

Often times the wow factor is also an emotional indication that something could be up. The first time Steve Jobs presented the iPhone in 2007, it was stunning to the audience at hand and later on the internet. Seeing a company’s product or service, or better yet, testing and using it yourself is a good indication of what it could do in the future. A product that impresses you right from the start, both in its appearance and usability, could serve as a promising indicator of its value and potential future profits.

Conclusion

There is no one specific factor or way to invest in startups. As Charlie Munger would say, find what works and then stick with it. If you find a way that works, drop it in the comments below!

Disclaimer

This is not Financial Advice. This article is meant only for educational and perhaps entertainment purposes.