Startup Investing

I'm on a beach in Cyprus, enjoying the sun and sand, and looking for the next big thing to invest in. It's an exciting day in the startup world - Y Combinator's Alumni Demo Day.

My Rental Car Adventure

I got in last night and picked up my rental car. To my surprise, the steering wheel was on the wrong side of the car. Cyprus apparently drives on the left side of the road. I also learned that Google Maps is not very reliable here. It asked me to drive up a flight of stairs in town!

But I made it safely. Now I'm taking a break to check out the latest startups.

Y Combinator: What's the Big Deal?

As you know, Y Combinator accepts about 1% of the 60,000 companies that apply each year. What happens after they are accepted?

• Top founders from around the world join a 12-week intensive bootcamp

• They actively build and sell their product while learning from each other and getting advice from successful mentors

• The mentors are alumni who have built companies worth billions or hundreds of millions of dollars.

• Demo Day: At the end, the new startups are presented to the world and venture capitalists flock to invest in them. Investors come reliably because Y Combinator startups statistically have the highest success rate.

• Alumni Demo Day: Several days before Demo Day, alumni of the program get special access to invest in the startups before the top venture capitalists.

Should You Invest in Startups?

I'm a big proponent of investing in startups, but it's not without its risks. Here's the real talk:

• 9 out of 10 startups fail

• Venture capital is one of the riskiest and most illiquid investments

• You typically can only cash out at the end if they go public or get acquired. More recently, there are secondary markets where you can buy and sell private shares

So why do venture capitalists invest in startups? Because that 1 success pays for the 9 failures and more.

The Numbers Game

Let's break it down:

• Data from Cambridge Associates found that the top two quartiles of VC funds had an annual return of 76.1% over 20 years!

• Early stage funds typically aim for 30-31% annual return

• Overall, performance of VC was found to be around 13.1%

• These are in comparison to 10.7% for S&P 500 and 3.1% for average annual home appreciation

Now, let's put that another way. If you invested $100k 20 years ago in different VC funds, an index fund, and a home, here's what each would be worth today:

• Home: $184K

• Stock Market Index Fund: $764K

• Average VC Fund: $1.2M

• Early Stage VC Fund: $22M

• Above Average VC Fund: $8B! Yes, $8 billion

That's how Yale achieved legendary returns for their endowment fund. It has grown from $1 billion to $41 billion in 4 decades because of an atypically high allocation in VC. They put nearly a quarter of their endowment in VC. That endowment now makes up the bulk of their operating budget. That and their doctors. Tuition only accounts for 8% of their revenue now.

So, you can make money off tech without ever building something yourself or consulting for a startup, but learning to identify good startups comes from being immersed in them.

In fact, it's common in Silicon Valley to hear that a tech founder has made more from startup investing than from their own successful startup. Sam Altman, the creator of OpenAI, was one of them. He likely made less than $10 million from the sale of his first startup, but made hundreds of millions from startup investments over the years since.

How to Get Started

For those still interested in investing in startups, I recommend a cautious, deliberate approach:

1. Learn the language: Read about startups, join communities, meet founders and investors.

2. Research: Look at lots of startups, but plan to pass on the first 20 while you learn

3. Budget smart: Only allocate 5-10% to high-risk investments like startups, and save the remaining 90-95% for safe investments. That’s Nassim Taleb's barbell strategy for maximizing possible upside while minimizing downside.

4. Do it together: This journey is best done with a friend to bounce ideas off of, so share this newsletter with someone that would be interested.

Picking Winners

Look for:

• Strong founders (they're more important than ideas)

• Growing markets

• Evidence that this is something people want

Y Combinator's Latest Batch

I'll share more next week, but here are two interesting stats that jump out: Of the 255 companies this batch, only 26 were in healthcare. And of the ~60 healthcare founders, only 3 were physicians.

Enjoy The Journey

Embrace being out of your comfort zone. It’s okay to look like an amateur while you learn.

I had my own amateur moment this morning. The security guard asked me if I could move my rental car to a different spot. We started an interesting conversation and stayed chatting for a while after I got in the car. I finally went to reverse, then realized I was sitting on the wrong side the whole time and there was no steering wheel in front of me. The security guard and I shared a good laugh.

It's okay to be a beginner. I'm getting the hang of this car, except I turn on the windshield wipers every time I want to signal.

Best,

Mohammed