The Golden Rules of Startup Investing

By Andre Turenne, National Grid Partners

I’ve worked in the technology sector more than 30 years – most of that time in venture capital. I’ve invested in more than 50 tech startups, and many have gone public or been acquired (most recently, RiskIQ).

There’s no magic bullet when it comes to spotting successful startups. But I’ve seen patterns play out again and again – not just in terms of deal sourcing, but also in terms of due diligence before an investment and what to do afterward to boost the odds of a successful exit. I’ve boiled these down into a list I call my “Golden Rules” of startup investing.

Here are 10 of those rules, which I’ve found hold true during boom and bust cycles alike and across technology sectors.

1. Deal flow, deal flow, deal flow: The ability to access and win top quality deals is everything.

• Really good VC firms have differentiators that separate them from other investors. My firm’s parent company is a good differentiator that can help get us into competitive deals: Startups like the opportunity to work with a category leader in the energy industry that can deploy their solutions at scale. Ask yourself what your differentiator is.
• Top-quality deals generally don’t just appear in your inbox.? You must go out and find them through personal networks or by literally cold-calling companies you’ve researched. A number of our portfolio companies were cold called by our investment team.

2. Category leaders accrue most all the value in startups.

• Particularly in software, where outsized valuations generally accrue to the top two or three companies in a category. Find them, figure out how to get into them, and invest in them.
• Don’t invest in the #4 or #5 company in a segment.

3. Timing can be critically important.

• The idea and team can be right, but market timing can be too early or too late – which can crater your returns.
• If there’s already a category leader and a couple other players, it’s probably too late.
• Ask yourself: Is the business model riding a macroeconomic, cultural, or technical wave? For example: Speech recognition went nowhere for 15 years, and VCs lost tons of money. Then the technology advanced enough where SpeechWorks and Nuance finally broke through in the late 1990s.

4. It’s better to pay a rich valuation for a great company than a good valuation for a mediocre company.

• ‘Nuff said.

5. Decline deals with grace.

• Do it by phone instead of by email if you’ve had one or more meetings.
• Try to explain why, where possible.
• Entrepreneurs can be a great source of future deal flow.

6. Always make blind reference calls – don’t rely on references provided.

• LinkedIn is a fabulous tool for this. Search your network for connections to the target you know reasonably well, so you can contact them for a reference and get honest feedback.
• Never ignore a bad reference! Follow it up, even if nine out of 10 are glowing.? Many people are reluctant to give bad references. But there’s usually a good reason for one.

7. Double down on your winners.

• Make follow-on investments in your best-performing startups.
• Invest as much capital as you can in them, even at higher valuations.

8. An underperforming CEO – or one whose skillset is not adapted to the stage of development – can destroy a promising company.

• It takes time, often up to a year, to get buy-in from other investors, then find and onboard a new CEO. Don’t wait until it’s too late to make the change.
• It’s preferable to find someone from your network over a search firm placement; those are hit and miss, as you can’t judge the intangible aspects.
• The right CEO can make the difference between mediocre and great company performance.

9. Don’t always seek to maximize the company valuation in follow-on rounds, even if you can.

• It can make raising the next round very difficult.
• Make sure the funding round provides enough runway to achieve milestone targets that enable an uptick at the next round.

10. Beware of IPOs of unprofitable or sub-scale companies.

• Sometimes they work during strong economic cycles. But companies with less than $100M in revenues don’t have many analysts covering them; this leads to price volatility and poor liquidity.
• Extremely bad liquidity can make offloading your shares after the lockup almost impossible.

BONUS RULE 11: Every financing is a crisis!

• If a company is doing well, investors are fighting each other to invest above their pro-rata.
• If a company isn’t doing well, investors are fighting each other not to invest.

?Andre Turenne is Vice President of Investments at National Grid Partners. He was previously a senior vice president of D. E. Shaw & Co., a global investment and technology development firm, and a Partner at D. E. Shaw’s venture capital unit. Prior to that, he was a managing director of NeoCarta Ventures and senior manager of strategic investments at Intel Capital. His investment experience spans a wide range of areas, including enterprise software & services, SaaS/cloud, IT & network infrastructure, IoT/connected devices, wireless and security. Andre has also held roles in engineering, operations and product marketing.