Tag Archives: Risk

The attractiveness of different investment stages

When I first started investing, I thought that the best investment opportunities were at the seed stage. In other words, I thought that the best opportunities were in being the first investor in companies. My reasoning was that, if you know what you’re doing, this is the stage when there is the greatest return potential.

However, in addition to the greater return potential, seed stage investments also feature the greatest risk, and the greatest competition. If you know what you’re doing, you can minimize the risk. However, you can’t change the competition.

The number of people who can lead a $500K seed round, or contribute $50K towards it, are numerous. And this number will only grow as technology in general, and software in particular, changes the way that things are done in more and more sectors. The result is that seed valuations are often pushed higher than what can be justified by seed companies’ underlying business prospects.

As the round size and the resulting check size increase, in other words in Series A and B rounds, the number of people who are competing for a deal declines. And my intuition suggests that the reward to risk ratio does not decline as much. In other words, series A and B investors occupy a more attractive part of the value chain than seed investors.

I’ve participated in a few later stage rounds, beyond the series B. However, I haven’t done so a sufficient number of times to have a feel for whether later stage rounds are even more attractive than series A and B investments. With time, perhaps I’ll find out.

What’s missing from this reasoning is your personal fit for different stages. For example, earlier stage investment decisions are more qualitative in nature whereas later stage decisions are more quantitative in nature. As a result, even if series A and B investments represent a more attractive part of the value chain, they might not be the right fit for a highly qualitative investor.

Getting in on the ground floor

After a new venture begins to take off, many people want to get onboard. Competition to join the venture increases.

However, at the same time, since the risks of the venture have decreased, the potential intrinsic and extrinsic rewards it offers also decline. So you’re faced with an environment that’s simultaneously more competitive and has lower prospective returns.

This is why you want to get in on new ventures on the ground floor. That’s when there’s little competition and it’s easiest to get in. It’s also when there’s the prospect of disproportionately high intrinsic and extrinsic returns.

The challenge, of course, is identifying the right new ventures to get into on the ground floor. Fortunately, you can take multiple swings during the course of your life. And with each swing you learn a bit more about the defining characteristics of the right new ventures. So your probability of getting in on the right one improves with time.

And you only need to hit one home run in your life. You only need to get in on the ground floor of the right venture once. The intrinsic and extrinsic returns of doing so are often enough to keep you feeling happy and successful for a lifetime.

But chances are that once you experience this thrill once, you’ll want to experience it again.