When is the best time to invest in startups?

It’s a wild time to be an investor. 2021 has become a record year for Venture Capital investment. More startup unicorns were minted in the last 3 months than during any year in history and the market doesn’t show any signs of slowing down. The number of unicorns (startups valued at over $1B) below has exploded.

It’s a wild time to be an investor. 

2021 has become a record year for Venture Capital investment. More startup unicorns were minted in the last 3 months than during any year in history and the market doesn’t show any signs of slowing down. 

The number of unicorns (startups valued at over $1B) below has exploded.

# of unicorns minted by year (Globally 🌎 as of 08/21): 

  • 2018: 178
  • 2019: 169
  • 2020: 163
  • 2021: 327 ​​🦄(and the year hasn’t ended!)

It’s a real sign of the times.

This hype is impacting early-stage investors too. 

Back in my day (2016), we could invest in a strong early-stage startup at ~$6M to $8M valuation. Today, top early-stage startups are getting valued at north of $15M! 

FOMO (Fear Of Missing Out….get with it!) is at an all-time high. There’s more money in the market than ever and investors are paying up to be part of the action. 

So why is the market so hot and what do we do about it?  

A red-hot startup investing market:

I like Fabrice Grindas take on today’s market. I’ll summarize his key points here.

Fabrice is the Founding Partner at FJ Labs, a venture fund based out of New York. Fabrice has over 250 exits on 700 angel investments with early investments in Alibaba (Market Cap: $433B), Coupang (Market Cap: $51B), Airbnb (Market Cap: $104B), Instacart (Raised $2.7B), Flexport (Raised $1.3B), Delivery Hero (Market Cap: $36B), and many more. 

Fabrice mentions in his blog post entitled Welcome to the Everything Bubble, that the “signs of market mania are everywhere. P/E ratios are high and climbing. Bitcoin rose 300% in a year. There is a deluge of SPAC IPOs. Real estate prices are rapidly rising outside of dense major cities.

His market analysis highlights a few interesting stats that help explain 2021 valuations: 

  • In 2020, wages only dropped $43 billion (March to November 2020): While many low-end service workers lost their jobs, higher-paying professional jobs were unaffected, and some low-skilled jobs boomed such as warehousing and grocery stores, leading to lower losses than might have been anticipated.
  • The scale of the government support programs was unprecedented: Unemployment insurance programs pumped $499 billion into Americans pockets. The $1,200 stimulus checks to most American households added another $276 billion. All in all, Americans had over $1 trillion more after-tax income March-November 2020, than in 2019. As a result, US bankruptcy filings hit a 35 year low in 2020!
  • Discretionary spending fell dramatically: Services spending fell by $575 billion as people did not go on vacation, to restaurants, movie theaters, sports venues, concerts etc. While Americans spent a bit more on durable goods, overall spending still fell by $535 billion.

When combined with the increase in personal income, Americans saved an extra $1.5 trillion!

Fabrice noted that while part of that extra cash went into deposits, a lot of it also went into investing, ultimately inflating asset prices. This comes on top of the flood of liquidity unleashed by the Federal Reserve and its commitment to keep rates near zero- in fact real rates are now below zero. 

So what do we do about it? 

Here’s what Fabrice recommends...

Rules for Investing in a hot market: 

  1. Own no bonds whatsoever. Yields are insanely low, and you are not being compensated for default risk. At the same time, you are at risk of inflation.
  2. Adjust your cash holdings to 20% or more of your assets.  You are not earning anything on that cash, and you lose the inflation value. On top of that it would be debased in a fiat currency crisis. However, having liquidity is useful in other types of crises where people take a flight to safety when bubbles burst. It provides safety, flexibility, and allows you to buy assets cheaply. At the same time, you can move out of cash, if necessary, should inflation spike.
  3. Avoid margin like the plague. While inflation decreases the value of your debt (and mortgages are ok), you do not want to be exposed to margin calls when the bubble bursts and assets decrease in value. Many wealthy people went bankrupt that way during the financial crisis of 2007-2008.
  4. Own high-quality stocks. They increase in value in an inflationary environment and retain more value when asset prices fall. In other words, do not suffer from FOMO and pursue the latest investment craze (Bitcoin, Gamestop etc.). This is not to say you should necessarily sell your Bitcoin if you own some. It is a form of digital gold that could be a good inflation hedge, but I would not be looking to add to my position at the current price levels.

Fabrice deploys a unique strategy himself...he doesn’t even own stocks.

He has a barbell strategy with only two holdings: 

  • Cash: 💰 is king!
  • Startup Investments: His theory, “if you have enough diversification (meaning over 100 startup investments) to account for the startups that fail, private early-stage tech startups are the best asset class. They create value for the economy and can grow rapidly. As such they are amazing to own in both inflationary and deflationary environments.”

My take? 

Everyone knows that “one guy with the mullet”. 

Sure, you may think they’re crazy, but they know something you don’t...a mullet isn’t a fad, it’s a lifestyle.

Startup investing is similar. 

We are playing a long-term game. We are investing in companies riding emergent trends on a 7-10 year time horizon. It’s impossible to time the market and even harder to determine how a tumultuous market will impact a startup’s future prospects. 

Moreover, we are playing in a game of outlier returns where one company can make or break your portfolio. If you sit on the sidelines and step out of the game, you may miss it. 

So when is the best time to invest in startups? Always.

I hope this provided a bit of context to the 🔥 market we are in today. Startup investing is en-vogue, but we’ve seen this before (e.g 2001, 2008, 2015). There will be a pullback when prices begin to normalize. For now, I plan on investing through these market cycles. 

Thanks all! See you next week ✌️