“Now that is a really hard question,” said the experienced angel and former entrepreneur.
“What question?” I asked
“How do you know when to stop investing in a startup?” he said.
We were attendees at the Angel Lounge at the ATDC. This is a monthly luncheon meeting I facilitate. There were 22 angel investors present that day. The objective of Angel Lounge is to become better investors by sharing our experiences.
I gave a brief presentation on the reduced risk of investing in entrepreneurs who serve the markets they came from. In short, the value of domain expertise.
But he didn’t hear this topic because one of his startups is struggling and needing more money. That means, as the lead investor, he is struggling. He is consumed with this question.
There are two reasons to stop writing checks for a startup. One is an easy decision. The other is incredibly difficult.
The easy decision is driven by your investment thesis and balanced portfolio approach.
Every investor has a limit of how much he will invest in a single deal. Even Warren Buffet spreads his risk. As angels, we do the same thing.
Angels shouldn’t have all their eggs in one basket. Entrepreneurs do but not investors. So when you hit your limit, it is prudent to stop writing checks. Even if it is still an attractive investment.
Then there is the second reason to stop writing checks. Is this startup still an attractive investment? This is the question my angel friend was wrestling with.
In my twenty-four years as an investor, I’ve been faced with this question. Write one more check or move on? What makes this decision so incredibly difficult is the money you have already invested combined with your ego.
Here are my three rules for when an investment is no longer attractive.
- The entrepreneur lost hope. This is the easiest of them all. If the startup entrepreneur believes there is no future, then there is no future. The money is lost. The company is done.
- You tried everything and the market is just not buying what you sell. The market may need it. Everyone agrees the market needs it, but nobody in the market is willing to write a check right now. This is frustrating but, in some cases, a reality. Accept it. Your timing was off.
- It will take too much money to get to positive cash flow. All the investors thought the startup could get to sustainability on an agreed upon number. That number keeps moving up and up with no end in site. With each new round, the return on investment goes down. It is time.
There is so much emotion in a startup. The entrepreneurs and the founding investors are fully invested with their time, talent and treasure. None of us ever want to give up hope. That’s why calling it quits is the hardest call of all.