Early Investing

A Truly Terrifying Tale of a Terrible Investment

A Truly Terrifying Tale of a Terrible Investment

My friend Jason told me it was a great idea. 

“He’s already got tons of regulars,” he said. “They love his drinks. And we would get shares at a discount because he knows my brother! He just needs some money to get this new place started.”

“I don’t have the cash to throw at this kind of thing right now,” I replied. “And I don’t know this guy. Sorry.”

Jason, however, was undeterred. He felt confident that this founder — a bartender who asked him to invest in his brand new “bar and grill and gaming experience” — had what it took to succeed. So he took the plunge and invested $2,000.

The decision would haunt him for the rest of his life. 

Immediately after investing, Jason tried following up with Nick, the founder. Nick blew off Jason’s repeated requests to meet in person and discuss the company. When Jason started emailing him and calling him, Nick only gave vague responses to his questions. 

Jason had invested in part because Nick had told him that a major venture capital firm had invested as well. But when he probed more deeply, he discovered that Nick had merely spoken to an investor at the firm in question — and had never actually landed an investment. 

Needless to say, Nick’s company never got off the ground. Jason ended up having to move out of his apartment a few months after he made this doomed investment. That $2,000 was all of his savings, so he had no cushion when he lost his job shortly after. 

These days, Jason is in a better place. But he’s refused to invest in any startups since that terrible experience.

I tell you this story not to make you afraid of investing, but to shed some light on lessons that all investors can benefit from. So to avoid ending up like my friend Jason, here are three steps investors should take before investing in a company.

Determine Whether It Fits Your Investment Philosophy

First of all, you need to ask yourself if the company you’re considering aligns with your investing philosophy. If you have an investment thesis — a reasoned argument for a particular investment strategy that’s backed up by research and analysis — then you can use that to evaluate the opportunity. If you’re primarily an impact investor who’s interested in climate-focused companies, then it doesn’t really make sense to invest in an oil company. If you’re a value investor who prioritizes startups with low valuations that may go up in value over time, then early-stage companies (seed or pre-seed) might make sense. It just depends on your philosophy.

Another essential part of this evaluation is check size. Don’t invest money you can’t afford to lose. It seems basic, but Jason is hardly the first or the last person to make the mistake of investing more than he should have. Determine your investing budget and stick to it. 

Do Your Research

I’ve said it before and I’ll say it again: research is essential. Make sure you really understand a company before investing. If it’s a startup that’s raising money on a crowdfunding platform, read through the raise page and offering circular carefully. Talk to the founder — in person if possible, but a phone or video call works too. Email is helpful but shouldn’t be your sole mode of communication. 

As I do my research, I like to note three things: red flags, green flags and things I have questions about. Ask the founder about all of them. And pay attention to how the founder responds to your questions. If they’re not giving you straightforward answers or they’re glossing over major problems, that’s a bad sign.

Jason made the mistake of investing in someone he barely knew. He liked Nick’s idea of a bar for gamers, but he didn’t take the time to grill Nick on how he planned to fund, build and eventually scale his business. He didn’t evaluate the business model, target market or comparable businesses. And he didn’t ask about Nick’s qualifications or previous experience building a business. If he had, he almost certainly would have decided not to invest. 

Consider Other Investors

After you’ve done your own research, it’s helpful to see what other investors think about the company. The presence of venture capital backers doesn’t necessarily guarantee a startup’s success, but it can be a positive signal. 

If it’s a crowdfunded startup, you can usually hear from other investors on the FAQ or discussion section of the company’s raise page. There you’ll see investors grilling founders about all different aspects of the business — and you may find smart questions you hadn’t thought of.

Of course, no investment is foolproof. Doing all of this doesn’t guarantee that you’ll never make a bad investment. Most startups fail. That’s the reality. Sometimes you — or a founder — will do everything right and the startup will still fail. 

But taking these steps can help minimize the risk that you’ll lose money on your investment… and help you avoid a horror story like Jason’s.

Top Posts on Early Investing