The WSJ published a story titled, "Web Startups Hit Cash Crunch" and there has certainly been considerable buzz about an impending crash. To wit: nearly one-third of daily deal sites have shut down this year, and many other "me too" business models are struggling to gain traction after raising cash.
The recipe for the froth seems pretty clear: a week economy is encouraging many people to take chances funding a start-up, while unpredictable public markets are encouraging investors to chase the next Google or Facebook. The problem is that most investors don't have access to start-ups founded by entrepreneurs with proven track records, since VC firms like, Sequoia, already have established relationships. While a lot of unlikely entrepreneurs are churning out business plans these days - and you never know, your neighbor looking for angel investors might have the next great idea - be very weary of the start-up mania that's occurring right now. Here are some tips for investing in a good start-up:
1) Truly understand the market and business model -- this seems obvious, but a lot of investors get caught up in ideas they don't entirely grasp. Do your homework and make sure the model can be monetized. I see far to many companies burning cash without a plan.
2) Make sure this is a unique model, and not another "Me too" company. While some clones will work or can be done better, the first mover advantage is huge. Just look at Craigslist.
3) Diversify -- most VC firms make 100% profits form just 10-20% of their investments (and don't expect to be seeing a success rate like that without serious connections). It's better to put $20k in 5 companies than $100k in one. Even great ideas, like mobile apps, can fail for reasons beyond anyone's control. The App Store and Google's algorithms can ultimately decide.
4) Vet management -- Lots of people have ideas, but far fewer are able to execute. And make sure at least someone on the team has experience in the market they're entering.
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