Startup Investing has emerged as an Investment option for many young Indian Investors. We are seeing the emergence of Venture Clubs and Angel Clubs in all major metros. These clubs pool together monies from many investors and invest in suitable startups. Investors can invest as little as 2.5 lakhs (sometimes lower) in each startup.
These clubs suggest that every investor can form a portfolio/ basket of startups that they invest in. The fundamental assumption is that many startups will go bust but the ones that succeed will give outsized returns and a well-diversified portfolio is likely to give above-average returns in terms of XIRR.
In my opinion, ordinary investors should stay away from startup Investing. Here is why:
- Venture Club communication only talks of success stories. They repeatedly talk about exits with high XIRR. Busts are swept under the carpet. Aggregate portfolio level returns are almost never talked about.
- Most VCs and their founders are not investing in every Startup that is being pitched to potential investors. They don’t have skin in the game every time. Since the VC conducts financial and legal due diligence, this arrangement can be counter-productive for investors.
- Many times, top international VC’s employees rig the system. Here’s how: say you work for a top-VC and that VC ends up funding a startup in China/ Mexico/ Brazil, you convince your Indian techie friend to start a me-too startup in India with the same hypothesis. On the other hand, you convince your VC to fund your techie friend with the same rationale as in China/ Mexico/ Brazil. Your techie friend returns the favor to you in monetary terms. In this entire process, only you and your techie friend walk away wealthier, investors walk away poorer.
- Startups start with a hypothesis. For example, Flipkart started with a hypothesis that if we burn enough money via cashbacks and discounts, we will change customer behavior to prefer us over physical stores. In some cases, this hypothesis is likely to work. But in many cases, it simply fails. In such cases, Founders have already invested their savings and years of effort into the startup. Even if they realize that their original hypothesis was incorrect and that they stand no-chance of ever turning profitable, they are unlikely to publicly admit this. This is because, no investor will commit more capital and their investments in the startup until that point will be marked down to zero. So they do the next best thing, they fudge the numbers.
All and all, this space is full of very few success stories and a huge graveyard of failures. If you are not directly involved with startups or have more intricate knowledge of this space than the ordinary investor, my advice is to stay out.