Rule #1 for investing in start-ups?
Diversification.
If you’re properly diversified, we believe you can earn the same level of returns as professional angel investors.
Last week, I discussed this belief with Dr. Richard Swart, the head of UC Berkeley’s crowdfunding research initiative.
As we traded points of view, Dr. Swart told me about a presentation he’d recently given. It was based on the results of several studies.
But one study in particular left me scratching me head.
Frankly, it led me to question whether individuals really can match the performance of the pros...
You see, now I’m now starting to wonder if you can beat their performance.
Professional Returns
First of all, let’s look at the average returns for a professional angel investor.
According to a study published by the Kauffman Foundation (an independent organization dedicated to studying and promoting entrepreneurship), the historical average return for angel portfolios is a whopping 27% per year.
To put that in perspective: if you earn 27% per year, you’ll double your money every three years.
Far better than the stock market, right?
But that’s the return for the professionals.
Should you expect similar results?
Going to Zero
It’s certainly possible… and several studies based on the Kauffman data concur.
But beyond the diversification rule, the study relies on a few core assumptions. The main one is that you have access to high-quality start-up opportunities.
These results won’t hold up if you’re investing in ice machines in Alaska.
Why You Can Beat the Pros
As we’ve written about, equity crowdfunding platforms give you access to high-quality opportunities.
In fact, according to Dr. Swart, crowdfunded deals might actually be better than those seen by traditional early-stage investors.
During our talk, he told me about a study performed at Crowdfund Capital Advisors on the Australian equity crowdfunding market.
Equity crowdfunding has been legal in Australia since 2007. That’s over 6 years of operating history, far more than we have in the U.S.
And the data is impressive: over $130 million has been raised for 176 companies.
But the kicker is the success rate of those businesses.
According to the U.S. Small Business Administration, only 50% of new ventures survive their first year.
Can you guess the survival rate of equity crowdfunded companies in Australia?
83%.
That’s 66% higher than the average U.S. company.
What’s the reason for this?
Dr. Swart had a few ideas...
Better Filters, Better Companies
For starters, many equity crowdfunding platforms require a start-up to pass a rigorous due diligence process.
In other words, the opportunities you’re seeing have already been screened by a team of investors.
Furthermore, if a company can successfully raise money from investors, it’s already demonstrated some important traits of a successful entrepreneur/company:
1. Resourcefulness & Tenacity – Raising capital isn’t easy. You hear a lot more “no’s” than “yes’s.” It takes thick skin and perseverance to see it through. The same could be said for running a successful business.
2. Salesmanship – To raise money for a new business, you need to convince people you have a good idea, and you need to convince them you have the skills to execute on it. It takes a salesman to deliver that message successfully. It also takes a salesman to help a company generate initial revenue, recruit a team, etc.
3. Proof of Concept – In traditional angel investing, only a handful of investors contribute capital to a company. With crowdfunding, a start-up will have dozens or even hundreds of investors. Since many of them don’t invest for a living, they tend to put money into products they’re passionate about. That passion comes from identifying a product they’d use themselves.
If dozens or hundreds of people find a product to be useful, the company has already started to answer one of the most critical questions a new business faces: “Will people even want the product we’re making?”
How You Can Beat The Pros
Here are a few rules that can help you increase your odds of investment success:
1. Stick to the equity crowdfunding platforms that do formal vetting. Most platforms clearly indicate which deals are vetted and which aren’t.
2. Follow existing investors into a deal. This goes back to one of our 10 Crowd Commandments. It shows that the entrepreneur has tenacity and salesmanship.
3. And finally, only invest in companies that have products you can see yourself buying and using.
Happy Investing!
Best Regards,
Founder
Crowdability.com
