Protect Yourself From Cocky Founders

By Matthew Milner, on Wednesday, July 16, 2014

The numbers are clear:

3 out of 4 start-ups fail.

For the founders of these companies, that means years of working around the clock, endless uphill battles, low or no pay...

And at the end of the road, 75% of them will have nothing to show for it.

It makes you wonder:

Given the tough odds and grueling lifestyle, why would anyone but a high-risk gambler take a shot?

Today we’ll get to the bottom of this question – and we’ll see what it means for you as an investor.

Survey Says…

Many people think entrepreneurs have a higher tolerance for risk taking.

Survey says?

False! Studies show that entrepreneurs are just as risk averse as the rest of us.

But they do differ from us in one key area:

Confidence.

That’s right: entrepreneurs believe they can prevent bad outcomes.

Oh, they’re a cocky bunch.

The Journal of Business Venturing, an industry magazine, surveyed about three thousand entrepreneurs. Here’s what they found:

  • 81% believed their start-up had a 70% or greater chance of succeeding.
  • One-third believed there was no chance that they’d fail.

Unfortunately for start-up founders (and for investors like you), these survey responses are as optimistic as a Disney movie. They fly in the face of reality.

To make things worse, many founders and investors have the impression that failing at a prior start-up improves the odds of succeeding on the next one. The thinking here is that failed founders learn valuable lessons that they're unlikely to repeat.

Makes sense, right?

Survey says?

False, once again!

A 2009 study of venture-funded start-ups suggests that founders who failed once aren’t likely to do much better the second time around.

And based on a more recent study of 8,000 start-ups based in Germany, founders who previously failed were even more likely to fail than first-time entrepreneurs.

3 Ways To Protect Yourself 

As a start-up investor, it’s important to be aware that founders, by their very nature, are overly confident.

They mean no harm – but if you’re not careful, your wallet might get hurt.

Here are three rules to keep them at bay:

1.Make sure the founder you invest in has domain experience.

If they’ve worked in the same industry before, at least they have reason to be confident:

Studies show that the risk of ruin goes down with relevant experience. It helps founders avoid expensive and time-consuming “trial and error,” and helps them connect with the right people.

The crowdfunding platforms that we cover here at Crowdability give detailed bios of the founding team, so this is an easy one to check for.

2.Make sure the founder you invest in has a co-founder.

The data are clear: companies started by more than one person have a higher survival rate. The Startup Genome Report found that “solo” founders take 3.6x longer to reach scale compared to a founding team of 2.

And “balanced teams,” where, for example, there’s one technical founder and one business founder, raise 30% more money and have 2.9x higher user growth than teams who are strictly technical or business-heavy.

As in #1 above, this is an easy one to do research on.

3.Make sure you diversify.

Founders toil for years and years on a single start-up. If they were playing Roulette, they’d be doing the equivalent of betting it all on black.

But just because they’re confident in their high-risk strategy doesn’t mean that you should be.

On the contrary, you can build a portfolio of start-ups – and that’s exactly what you should do.

To be properly diversified (to get into the realm of 2x to 3x returns on your overall early-stage portfolio) you should invest in at least 25 to 50 start-ups over time.

Investing in several hundred of them would be even better.

So if you want to build a formidable defense to the confidence of start-up founders, make sure to follow these 3 rules.

Happy Investing!

Best Regards,
Matthew Milner

Founder
Crowdability.com

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Tags: Diversification Domain Experience

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