How to short startups

Shorting startups is a tricky game, and there’s no direct or standardized way to do it like you would with public equities. Based on the most helpful WSO content, here are some insights and strategies to consider:

1. Shorting Publicly Traded Startups:
   If the startup has gone public, you can short its stock like any other public company. However, this comes with risks:

   • Overvalued companies can stay at frothy valuations for years.
   • You need clear catalysts for the stock to drop, such as missed expectations, SEC investigations, or signs of fraud.
   • Be cautious of buyout risks, as acquisitions can force you to close out your position at a loss.

2. Betting on Failure Through Derivatives:
   For startups that are still private, you might explore indirect methods:

   • Secondary Markets: If employees or early investors are selling their shares on secondary markets, you could potentially take a short position by borrowing and selling those shares. However, this is rare and highly illiquid.
   • Credit Default Swaps (CDS): If the startup has issued debt, you could buy CDS to bet on its default. This is more applicable to larger, late-stage startups with significant debt.

3. Creating a Betting Pool:
   While unconventional, creating a betting pool could be an option. You’d essentially be setting up a private market for wagers on startup failures. However:

   • This would be more of a speculative game than a true shorting mechanism.
   • Legal and regulatory hurdles could arise, depending on your jurisdiction.

4. Focus on Catalysts:
   Successful shorts require clear catalysts. For startups, these could include:

   • Running out of cash (most VC-backed startups have 8-12 months of runway).
   • Changes in market conditions (e.g., cooling IPO markets, rising interest rates).
   • Policy changes that impact their business model (e.g., Socialcam’s decline due to Facebook policy changes).

5. Alternative Strategies:

   • Competitor Investments: Instead of shorting a startup, invest in its competitors who are better positioned to succeed.
   • Hedging Through Related Public Companies: If a startup is disrupting a public company’s market, you could short the public company as a proxy.

While these methods exist, shorting startups is inherently challenging due to their private nature, lack of liquidity, and unpredictable timelines. If you’re serious about this, you might want to focus on building a network to gain insider insights or explore niche financial instruments that could align with your strategy.

Sources: From PE >> Startup >> Back to PE, Which investing strategy will be most challenged this decade (‘20 through ‘29)?, Shorting Stocks: My Research Process & 7 Rules I Follow, Your best sourcing tips