How to mitigate risk when investing in early stage startups

This article was republished with permission from the author’s blog.

Andreessen Horowitz recently revealed that its investment of US$250K in Instagram became $78 million. Thats a multiple of 312. Investing in early stage ventures is indeed very rewarding yet inherently risky. It thrives on multiple high risk bets out of which one or more would achieve high rewards.

But that certainly does not mean putting blind bets on anything that comes your way. Those who believe in “Spray and Pray” kind of investing are often losers in the long term.

Most VCs through their experience would have developed some sort of an internal braincloud (mental) checklist which gets ticked during the pitching sessions. Relying on mental checklists again is risky. Some or more of those check points might get sidelined if the idea falls into one of the soft spots of the more influential team members.

So how can venture capital funds systematically mitigate undue risks?

Here is a list of risks inherent in Venture investing along with practical risk mitigation strategies and if needed a ‘Jugaad’. Jugaad is a colloquial Indian term that means a creative idea, or a quick workaround to get through commercial, logistic or law issues.

1. Risk of the unknowns

Most people think a business is after all a business whether it is hi-tech or low-tech. If it makes money, why shouldn’t one be part of it? Some argue that if one understands the need of such a product/service, one qualifies to invest.

But most would forget that it takes a lot more for a venture to succeed than just a great idea. The devil is always in the details and in execution. If you come from an e-commerce background and are offered an opportunity to invest in an orthopedic surgical device, think twice.

How would you figure out what is the right amount of field trials you need to carry out before pitching it to potential acquirers? What makes more sense – licensing the technology to an existing player or go solo?

Mitigation: Invest ONLY in areas where Fund Managers have some domain knowledge.

Jugaad: If you are excited to support an idea where the investment team does not have relevant expertise, the fund management should think about appointing an advisor who knows that domain and is willing to work closely with one of the investment team members.

2. Risk of working remotely