Investing for Later-Stage Entrepreneurs

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A few weeks ago, I wrote an article about a frequent question from readers: How you should invest your money if you haven’t yet had a big exit or liquidity event - when you find yourself as an early-stage entrepreneur, just beginning your start-up-journey.

Today, I want to provide the natural sequel to this article: Investing for Later-Stage Entrepreneurs.

As I had mentioned last time, a 10M€ Series B was massive when I moved to Berlin in 2018. Today, some rounds are considerably larger, easily reaching 20M€, 30M€, or even larger sums. And as a result of that, the financial outcomes for founders at the point of Series A, Series B and beyond have also improved somewhat: They can command competitive salaries, and more importantly, they can make use of so-called secondary transactions, in which they can sell a part of their shareholding as part of a larger round, often netting them six- or seven-figure sums even when an exit is still a few years away.

It is at that point that such founders ask me what I think they should do with what is typically their first million - raising questions that range from where they get the best interest rates to which investments make sense for them.

So today, let’s tackle those questions.

Secondary - to sell or not to sell?

Before we dive in, let’s answer another question: If you are a founder who has an offer from investors to buy some of their shares, should you do it, or not?

As I had mentioned in the prior issue of this series, most founders are very optimistic about the pursuits of their business. Perhaps irrationally so, given that no founder would be worried about the long-term prospect of their business after closing a successful funding round. As a result, they think they might lean towards holding onto shares to sell them later at a much higher multiple - forgetting that the odds of actually reaching an exit, even after a large A or B round, are still not high. One recent example is the case of virtual events start-up Hopin, whose founder allegedly sold $195M (!) of shares before selling the entire business for a mere $15M.

So should you sell, or not? I would carefully lean towards yes, especially when it comes to your first secondary. I’ve seen many founders raise richly-valued Series A and Series B rounds on the basis of what looked like clear product-market-fit, only for their product to struggle just months later for a variety of reasons. Remember that large financing rounds bring equally large liquidation preferences, so if the company doesn’t manage to return to a growth trajectory, founders often become stuck with what might be a large percentage stake of low value - perhaps an even worse outcome than a bankruptcy. And in regards to the opposite, I don’t know a single founder that regrets a secondary - after all, a six- or seven-figure secondary, paired with a low cash burn, might set them for life.

What To Do Before You Invest

So let’s say you’ve found yourself as one of the lucky few: Your company raised a large Series A/B round, as part of which you were able to cash out a million euros from a secondary sale. You know your company has a long way to go, but if your vision for it works out, your million euros might be dwarfed by future exit proceeds. How should you think about investing? Like in our prior article about earlier-stage entrepreneurs, let’s start with everything but the investments.

First, the question of personal finance. Regardless of the state and stage of your business, you should have a clear overview of your personal budget, including rent, cost of living, insurance, and any expenses (or savings) for your family, like saving for your children’s education. Make sure that even with the prospect of a million euros in the bank, that figure does not change, and more importantly, make sure to negotiate with your investors for a salary that covers at least that figure. Regardless of whether you have nothing or a million in the bank, being ‘break-even’ in your personal finances is a substantial benefit, as it gives you significantly more flexibility in how aggressively you can invest your proceeds. If you followed the advice from the prior article of this series, you might’ve already asked for a salary of that magnitude during your Seed round, and can now ask for a raise that lets you save up money every month. You could also keep your salary the same, but ask for more ESOP, or of course, both of those things.

Second, make use of benefits at the company level. I don’t mean Adam Neumann-esque private jets, but actual, reasonable benefits that your investors can get behind, as they might make the life of your and the company easier. In my experience, that includes executive benefits such as a coach and/or private trainer (to make sure you are in peak mental and physical shape), an executive assistant (to help you with both personal and private matters), or more traditional yet still meaningful benefits such as a company pension scheme (Betriebliche Altersvorsorge). Of course, reasonable is the key word here: Make sure to include your investors in any such decisions so they don’t find out about your five-figure executive coach from a footnote in your investor reporting.

Lastly, perhaps on the verge of non-investment: Make sure that your proceeds are stored safely and in a way where they generate relevant interest income. If held in cash, be mindful of deposit insurance by diversifying across banks or holding it with major, stable banks, and ensure that you receive competitive interest close to the ECB’s deposit facility rate (EUR) or the Fed Funds Rate (USD). You might also consider things such as money-market funds or short-dated bonds. (Helping entrepreneurs manage their excess liquidity is one of our strengths - if you’re interested, don’t hesitate to reach out.)

Investing As Entrepreneur: A Question of Time

With that in mind - let’s finally think about actual investments. Frequent readers know about my love for the Aspirational Investor Framework - let’s use it for those purposes as well:

First, the Safety Bucket - investments to protect you in case of emergencies and/or short-term loss of income. The easiest ‘investment’ here is cash in your bank account, or if you want to be more nuanced, a money market fund or a short-term bond ETF. What I would also categorize here is a personal residence, which I think can be a great way to spend your first million - assuming you buy it in cash or use modest amounts of leverage, you can considerably reduce your ongoing living expenses, and know you have a roof over your head no matter what happens with your business.

Second, the Market Bucket - investments that allow you to maintain your lifestyle (i.e. income) over the long-term, especially after inflation. Here, you’d allocate to your traditional, diversified portfolio of liquid investments, most notably fixed income and equity ETFs. Depending on the magnitude of your secondary, you might also consider some illiquid investments - most frequently, I see investment real estate as well as private equity / venture capital fund investments (more on that below).

And lastly, the Aspirational Bucket - investments that have a significant risk of total loss of capital, but if they succeed, might yield considerable return. (It is also where I’d categorize ‘treat yourself’ purchases, such as a nice car or watch.) In the portfolios of later-stage founders, this category is dominated by the value of your stake in your company. Other frequent investments here include crypto as well as start-up investments (more on those also below). 

Across these categories, if later-stage founders asked me where to spend time and money (and where not) - I typically tell them the following:

You can never go wrong with keeping your money in the Safety Bucket. You might think that you’re losing out on higher-returning investments, and that is not wrong, but don’t forget that your overall portfolio will almost certainly be heavily skewed towards the Aspirational Bucket. As I’ll touch on in more detail in a second, any investing activity takes up time, which is your most valuable ‘asset’ at that stage of your career.

You can invest some money into a diversified, liquid portfolio, but be mindful of other diversified investments. If you want to spend a little bit more time to achieve a slightly higher return, you can go the easy way and invest some spare capital into a globally diversified equity ETF. (I also wouldn’t be offended by a single-percentage allocation to some of the ‘large-cap’ cryptocurrencies, which we would allocate in the Aspirational Bucket.) But be careful when it comes to fund investments: More often than not, portfolio founders get offered to participate in the subsequent fund of one of their investors through “friends and family” vehicles with lower minimum tickets. They sound good on paper, and if the fund isn’t a total disaster, you should generate a return comparable to its respective public benchmark. But don’t underestimate the associated work, such as capital call management, taxes, and bookkeeping, which are all things that take up your valuable time. You’re also likely not able to reach the level of diversification that a fund portfolio should typically have (especially in venture), which might leave you at higher risk than intended.

And most importantly:

Avoid any type of time-intensive investments. 

Through one of my family office jobs, I had the opportunity to work closely with the founder of one of Germany’s fastest-growing start-ups. He was a serial entrepreneur, having already sold another company for a significant sum. When I first started working with him, he had started to work with one of his former employees in starting his own family office after closing on a substantial secondary transaction. But by the time we met again a few months later, he’d actually shelved his family office plans: It had become clear to him that spending time on any investment but his rapidly-growing company would likely yield a worse financial return - deciding even against hiring said employee to take care of non-investment matters. He’s not the only (successful) founder with that mindset that I’ve encountered.

Admittedly, it is quite a strict view. I do understand that entrepreneurs, especially those that are approaching an exit, want to slowly dip their toe into the world of investing, using what hopefully will be a small sum (even if it’s a million!) relative to their later exit proceeds. In Germany, we’d call it play money (Spielgeld), and I tell founders that it’s better to wager and lose some of that amount than their substantially larger sums from selling their business.

But even if you want to get started on such investments already, let me reiterate my prior point: Be careful when it comes to investments that might need you to get involved - such as real estate or direct start-up investments. On paper, they look like passive investments, but from personal experience, I can tell you that it’s very easy to get dragged in, especially in the case of investments that are not going well. And all of a sudden you find yourself spending hours on the phone with the founder you invested in, or in touch with the management company because of a water leak - not the things you should be spending time on as an entrepreneur. But even if they do well, it’s likely that the financial impact will be marginal for everything but true outlier investments, given your limited capital - so in my view, it’s best to stay away.

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