Last Friday, a British entrepreneur named Cliff Dennett put on a well-pressed shirt and blazer, took a deep breath, and sat down for a painful interview.
During the videotaped interrogation, which we’ll link to below, Cliff opens up about why his start-up failed—and why his investors lost all their money.
Today, we’re going to take our own look at what happened.
This isn’t pretty—but it’s incredibly important:
It reveals the number one rule for protecting yourself when investing in start-ups.
On Top of the World
In January 2014, a new Internet start-up called Soshi Games was on top of the world.
With Cliff at the helm, Soshi was poised to take advantage of an exciting opportunity:
More than 100 music artists on Facebook and Twitter had at least 10 million fans each—but the artists weren’t making any money from these fans.
At the same time, online games were taking off like a rocket: these games were generating hundreds of millions of dollars in revenues.
So Soshi aimed to fuse these two trends by providing rock stars like The Rolling Stones and Queen with their own online games.
Soshi would create the games, the rock stars would bring the audience—and the two partners would split the revenues.
So what went wrong?
Given the opportunity, Cliff thought rock stars would be lining up at his door.
He estimated it would take 3 months to get a few big contracts signed, then Soshi would be “off to the races.”
Unfortunately, things didn’t go as planned:
Among other challenges, it took 18 months just to get one deal signed.
The problem was that Cliff was new to the music world, so he had to spend months and months building relationships, and learning the ins and outs of the business.
As he recounts in the video, “I had to negotiate the complexities of the music industry, pretty much with zero knowledge.”
To his credit, he eventually signed the 80s rock band, Queen, and launched a game—
But by then, the gaming landscape had changed…
And Soshi’s money had run out.
Could things have worked out differently?
We’ll never know for sure, but if Cliff had been a music industry insider—if he’d had what we call domain experience—his odds would certainly have been better.
For example, if he’d already known the right people, perhaps he could have signed a deal and launched a game far more quickly.
That’s why, in our essays and our Early-Stage Playbook course, we teach you about the importance of the founding team, and how to look for founders who have qualities like domain experience.
But there’s something else going on here that’s even more important…
In fact, it’s the single most important rule for start-up investing.
Rule Number 1: Build A Portfolio
At Crowdability, we often talk about the investments that go right…
For example, our colleague Howard Lindzon’s investment in Uber:
That one investment returned 400 times his money. For every $5,000 he invested, he got back $2 million.
But professional investors like Howard don’t just invest in a start-up or two like Uber or Soshi and expect them to be winners…
They understand—based on the historical odds of early-stage investing—that many of the companies they invest in won’t work out.
So over time, the pros build a portfolio of start-ups. At a minimum, they aim to invest in 25 to 50 companies.
27% Annual Returns
Think about it like this:
Let’s say you invest in 50 start-ups, putting $1,000 into each—so $50,000 total.
And let’s say that 49 of those companies go out of business, just like Soshi did.
But if one of them—just one—turns into the next Uber or the next Facebook, you could still make a fortune. If it returns 400 times your money, like Uber did for Howard, that $1,000 investment would now be worth $400,000.
That sure beats the returns from the stock market.
In fact, in a study conducted by The Kauffman Foundation, a large non-profit that studies entrepreneurship, the historical average return for start-up investors has been 27% per year—and that includes all the investments that went to zero.
And keep in mind:
27% is three to four times higher than the historical returns of the stock market.
It’s enough to double your portfolio value every 3.5 years.
Dennett did an admirable job as CEO…
But as he describes in his video interview, sometimes things just don’t work out.