“There is a lot of money in circulation, and the best entrepreneurs make a very careful choice as to which investments and investors they want to bring along on their journeys. The money is the same, no matter where it comes from, but if you as investor also can offer some unique knowledge and expertise, then your attractiveness will grow exponentially in the eyes of entrepreneurs.”
- Stefan Backlund, Katalysen Partner & CMO
In a recent article in Sweden’s leading provider of financial news, Dagens Industri, five of Sweden’s most successful and renowned angel investors offered some of their advice on how to successfully invest in private businesses. These five included Katalysen’s very own Stefan Backlund, of Klarna and Trustly fame, and now Partner and CMO at Katalysen. The group also included former Swedish Minister of Finance Anders Borg, Pricerunner CEO Nicklas Storåkers, previous SEB and Handelsbanken head Ann Grevelius, and Bestpoker founder Henrik Persson Ekdahl.
Money keeps pouring into Swedish startups, and an important part of this ecosystem are angel investors who invest in early stage companies. These angels are often themselves entrepreneurs, but it is not only the professionals who can own a piece of promising private businesses. However, according to a new survey from analytics provider CB Insights, almost half of all startups that fail do so because of low market demand for their product or service. Only 30% of failed startups fail due to a lack of funding. With this in mind, we asked Stefan to take a few minutes out of his busy schedule to elaborate on some of the lessons he has learnt while investing in private businesses. For further insights on how to avoid the traps and benefit from the opportunities of early stage investing, be sure to check out the article Sveriges affärsänglar: Så blir du vinnare på att investera i onoterat (in Swedish).
What fundamentals would you recommend a prospective investor to keep in mind while investing in private businesses?
There is a lot of money in circulation, and the best entrepreneurs make a very careful choice as to which investments and investors they want to bring along on their journeys. The money is the same, no matter where it comes from, but if you as investor also can offer some unique knowledge and expertise, then your attractiveness will grow exponentially in the eyes of entrepreneurs.
It is also important to spread your risk in a smart way. One way is by only investing a small part of your total wealth in private businesses, another is by only investing small sums but in 10-20 different private businesses.
It typically takes longer for private businesses in a startup phase to achieve certain key milestones: gaining trust in markets, obtaining paying customers, and building a team. These may be very exciting times, but it can be frustrating to wait for “the stars to align”. Once they do align, it’s the best feeling in the world.
Which are the most significant risks with investing in private businesses?
Tying up your capital over a long time horizon is one significant risk. The attractiveness of your stocks on a secondhand market is typically very uncertain, should you for any reason be forced to sell early. Another point of liquidity is the fact that you need funds to make follow-up investments in later rounds. This is partly to protect your ownership stake again dilution, but also to ensure you will be able to support firms you’ve invested in should they themselves end up facing liquidity challenges.
Another risk to keep in mind while investing in early stage businesses is the lack of transparency that typically exists. Entrepreneurs frequently try to downplay problems and challenges, while overplaying solutions and opportunities. This means that the investor may not find out about crucial challenges facing the business, and thus relies on overly positive expectations. This can lead to significant friction. If you are instead able to view the relationship between the investor and business as a partnership, with both partners being in the same boat, then things get much easier. We at Katalysen & Partners are convinced that this is a key factor to long-term success.
Occasionally you can observe other early stage investors: these may come in the form of family offices, small venture capital firms, or state-run development funds. Such actors usually have a framework in place for screening promising companies – doing so called due diligence – which evaluates the prospective investment object’s economics, technology, patents, market potential, etc.
How important is patience, and what’s a reasonable expectation for the return on investment?
An early-stage investor’s patience ought to be endless, but your expectations for the return on the investment can be significantly higher than they are for other investment classes. The earlier you invest in a company’s life, the higher the risk grows, but also the return multiple that you can expect should everything work out well.