Entrepreneurs beware of DIY Investing!

I have  people who ask me this question. They think that because i started a business, sold it and because i make private investments that there is something special or unique about how i invest my assets. Let me be the first to say that the traits required to be a good investor are very different from those that entrepreneurs have. And i think i am still learning from the market and about myself all the time.

By default, entrepreneurs are high risk takers who control the risk by knowing everything there is to know about their business and industry. We deep dive into every aspect of our work so that we are able to control risk and maximize our returns. Even when our business has grown a lot, we continue to invest more into it and take further risk by going overseas or into adjacent markets. Frequently, the company we own is most of our net worth.

Furthermore, Entrepreneurs are also highly passionate people and you will hear many successful ones who advocate a combination of gut and metrics to make major decisions.

Good investors on the other hand, diversify. They minimize risk by not concentrating in one area and by proper portfolio allocation. And it is also humanly impossible for them to know with any depth any particular industry which they are invested in. They frequently outsource and use professional managers to help manage their money. Decisions are made based on numerical allocations and frequently a fixed methodology for deciding when to buy or sell. Investors who employ their gut tend not to do well. 

My personal experience is that the above descriptions are totally true and one can lose a fair sum of money if one does not understand the very different traits required. I lost close S$100K or 100% of portfolio during the 2000 dot com crash because i had over-concentrated my positions in technology stocks. Then more recently in 2010, i experimented with options without clear knowledge of how volatile they can be and lost another S$100K on these simply because i could not cut my losses and applied the dogged perseverance entrepreneurship trait to options!

From the above lessons, i learned that it is best for me and perhaps for entrepreneurs like me to stick to passive portfolio decisions and outsource the active selection decisions to good fund managers. 

What this means is that we should make the decision on how much to keep in cash, how much to invest in stocks, fixed income and properties. But when it comes to the actual stock or fixed income picks, either buy ETFs which mirror the market or buy a few different mutual funds. Use dollar cost averaging strategies if we get more cash and rebalance the portfolio periodically every 3 to 6 months. 

If the urge to take risk or to make decisions is too strong and if we have an interest in trading, then set aside a small percentage of assets - say 5% to make speculative trades on equities, options or bonds. The above philosophy has worked well for me and i hope it will work readers too. 

How to think about Revenues and Costs in a startup

Over the years, i have been both running internet business and investing in internet businesses. In both cases, management will always have a profit and loss projection for the year. I have seen enough internet P&Ls and tracked enough such P&Ls that i have come to some conclusions for our region. Here are 2 major  :

1) Revenue projections are almost always optimistic.

I have must seen and helped or tracked more than 100 internet businesses by now based in SG and MY. Of these, only a handful have revenue projections that are largely achieved. And these are usually achieved due to market conditions being extremely favourable. A good example is Groupon SG and MY which rode the adoption of ecommerce in a big way. Or job portals and property portals which rode the economic growth and property market growth. Of course execution matters equally too. Usually companies that achieve their projections are those who executed very well on a day to day sales and operations basis and which are also aided by market trends which added wind to their sails.

What about the rest? Most of the other startups fall short of their projections. A common mistake is to assume a certain conversion rate for platform plays without taking into account that as one scales up, the conversion rates could change for the worse. For sales team plays, a common mistake is to assume scalability of sales staff without taking into account the fact that it takes time to train up a sales staff and that attrition for corporate sales startups is pretty high. Also sales management is not something easy to get right from the start.

Another common mistake is to assume revenue from new markets based on old market assumptions. I have seen many business plans where SG makes X revenue and the assumption is to grow MY and ID at the same pace as SG. This is quite dangerous. Many reasons. One is that core team that made it work is still in SG and not the new country. Another reason is that SG core assumptions are significantly different from new market. Another close parallel of this is assuming in your projection that you can sell a complementary  product as easily as your core. For example, an ecommerce company thinking that it can branch out and sell to the same clients advertising media.

2) Costs are usually at projections or worse above projections.

On the other side of the income statement, most startups manage to spend what they say they will spend. Unfortunately, when coupled with (1), this means many startups fail to hit their EBITDA goals. While not damning if they are growing fast enough, some startups do get caught and run out of cash.

Implications of the above 2 observations.

If the above 2 are usually correct, then it means that startups should always have a ultra conservative plan which requires them to project revenue at the worst case scenario and then spend at the worst case scenario. And be reactive enough so that if revenue comes in as expected, then ramp up the cost to match it. But never let cost ramp up in anticipation of revenue.

Now i know some people will say that is extremely conservative and startups that practise what i just suggested probably cant scale up super fast. Also, some people may also wonder how such a startup will get funded. I have 2 answers for this.

First, use your average to optimistic scenario for fund raising but use your conservative one once you get funding. This will solve your funding valuation issue and investors usually dont mind if the entrepreneur is more careful with their money.

Second, it really depends on market adoption or revenue growth. If market are growing like crazy (read over 100% per year), then yes, by all means ramp up the costs. But if market is still those that require you to educate clients (like job portals during the 2000-2003 days)... then perhaps it makes sense to pace costs to revenues.

Feel free to comment!