7 Mistakes New Startup Investors Make

Three-quarters of venture-backed firms don't return investor capital. Here's why.
(Gajus/Shutterstock)

(Gajus/Shutterstock)

The day you, as an entrepreneur, had dreamed and hoped for has finally arrived. Someone has decided to buy your company for a vault full of money. Your spouse already has plans for that new addition to the house or that European vacation that you have put off as you built your business.

After taking the trips you have missed, buying the Tesla that says you are one of the elite entrepreneurs in the land and you have golfed so much that you are wearing golf attire even to family functions, you decide, like an addicted gambler that you are in need of some action. You have some ideas to start a new venture, but family and friends are questioning your sanity. Frankly, you aren’t sure you have the stomach to do it all over again. Instead you’re going to get your fix through investing in startups.

The reality is that about three-quarters of venture-backed firms in the U.S. don’t return investors’ capital, according to recent research by Shikhar Ghosh, a senior lecturer at Harvard Business School. If failure is defined as failing to see the projected return on investment—say, a specific revenue growth rate or date to break even on cash flow—then more than 95 percent of start-ups fail, based on Mr. Ghosh’s research. According to the Angel Capital Association, Angels lose all or most of their money in 52 percent of the deals they invest in. Here are seven things every investor should consider:

  1. Love sexy technology: A friend of mine saw a presentation for a company that had an energy generation product that used people power. I asked him what he liked about the venture and he said he thought it was so cool. Did they have any letters from anyone saying they wanted to buy it? Aside from putting in money, what could he personally do to make a difference in the future of the company? This is a critical question every investor should ask to increase their chances of getting a return.
  2. I Love It So Will Everyone Else: One of my former investors was on the board of a sports related company and told me he saw a product that had the logos of a major sports team on it. He was so enamored he invested millions of dollars. The world, which he didn’t have a third-party survey or he didn’t even ask, did fall in love like he did. Hopefully, he made money in another venture so he can use this loss to offset his capital gains.
  3. Ivy Leaguers/Elite School Students Always Succeed: They look at Mark Zuckerberg, Bill Gates, Sergey Brin and Reed Hastings thinking these guys are infallible. Aside from being smart, Ivy Leaguers and other highly educated entrepreneurs fail at the same rate as everyone else.
  4. Surveys Never Lie: I personally learned this. I created the first insurance product to insure small business bank accounts against cyber theft of funds. Our surveys and surveys by our investors pointed to a big hit. My investors and I weren’t the first to believe surveys. Malcolm Gladwell wrote a great book called “The Tipping Point,” that talks about how Coca-Cola believed the Pepsi taste test, and we all know how that turned out. Coke created New Coke and to say people didn’t like it is an understatement. After investing billions, Coke found out that people like the initial taste of Pepsi, but when having to drink a whole can, Coke came out on top.
  5. Smart People Never Make Mistakes: If someone had a high GPA from a great school, was successful at a large company, people think they are infallible. They don’t question their assumptions and how they arrived at their numbers and the strategy to meet those numbers. I taught MBA students at the Wharton School of Business at the University of Pennsylvania for 10 years, which were arguably the smartest people on the planet. Amazingly, most knew so little about how the sales process worked.
  6. First to Market Wins: Do you remember Mosaic or Netscape? What about Altavista, Lycos, AskJeeves and LookSmart? All of these companies came before Google in the search engine business. Yet today, Google owns 67 percent of the search engine business, according to comScore. Being first to market gets you a lot of publicity, but often people aren’t ready for a product/service and those who follow are able to learn from those who came before. Investors worry if they aren’t invested in the beginning of a new industry they will have missed the opportunity. They don’t realize the first movers have to spend a lot of time and money educating the market. The companies that follow benefit by what the market has learned by the first movers. Plus later movers can learn from all of the technology, marketing and sales mistakes. Remember Friendster, they were the first online social service, and they told their users they would have to approve the friends they wanted. Facebook saw users didn’t like it so they said users can invite anyone they wanted. Now who owns the market?
  7. They Need My Advice: College student’s need your advice on running a business and even those people are more sophisticated than you would think. What companies really need, besides your money, is potential client contacts. It’s all about sales. So if you think sitting around the board room pontificating on the best way to manage purchasing, save your money and invest it in a Large Cap mutual fund.

The key to succeeding as an investor is picking companies with big established markets that only have a few players with entrepreneurs who are marketing and sales driven, good listeners and where your contacts can help drive sales you can substantially increase your chances of success.

Marc Kramer, president of Kramer Communications and executive director of the Private Investors, is a Philadelphia-based serial entrepreneur, author of six books and an adjunct college professor.