David Cummings on Startups

Cash Requirements for a Broad Angel Investment Portfolio

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David Cummings

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Three weeks ago a friend reached out to me about investing in tech startups. Now, he’s a corporate guy and has never been involved in startups, yet he wants to put some of his hard-earned savings into risky tech upstarts. His question reminded me of Jason Lemkin’s great post Why You Almost Certainly Shouldn’t Be Doing Seed Investments. The idea is as follows: an angel needs a broad portfolio of angel investments to do well (the same reason Vanguard is such a great product for public equity investors), seed investments of $25k or $50k also need follow-on dollars, so to do angel investing right, you need at least $1 million of cash.

Let’s look at the math:

  • 20 investments at $25,000 each results in $500,000 (so, a portfolio of 20 startups)
  • 5 of the 20 make good progress, so an extra $50,000 is invested in each, resulting in another $250,000 (important to reserve at least $2 for every $1 invested for pro-rata participation in future rounds — many people recommend reserving $3 for every $1 invested)
  • 1 out of 20 is a rocket ship and another $250,000 is invested in it to maintain pro-rata
  • $500,000 of initial investments plus $250,000 for first follow-ons plus $250,000 for a second follow-on results in a requirement of $1,000,000 in cash for a broad angel investment portfolio

Most people don’t have $1,000,000 in cash ready to invest in startups, and those that do don’t like the idea of little-to-no liquidity for 7-10 years (see Lack of Liquidity with Angel Investing). The cash requirements for a broad angel investment portfolio is much larger than people think.

What else? What are some other thoughts on cash requirements for a broad angel investment portfolio?

Comments

2 responses to “Cash Requirements for a Broad Angel Investment Portfolio”

  1. Dick Reeves Avatar
    Dick Reeves

    David, I think you are being a little harsh here on the requirements. In the angel group that I managed for 10 years the average check written was $27,000. But … the minimum check requirement was $5,000, and many members were happy investing at that level. In fact, those that wrote smaller checks invested more frequently, which led to a more diverse portfolio, which led to better outcomes for them. Further, the portfolio is built over 4-7 years, so not all that $1 million is needed on the front end. In fact, I think angels investing at the lower end can get by on $30K-$40K per year, which will let them do 4 new investments and a couple of follow-ons each year. Key to this is investing as part of an organized angel group, where they can have the benefit of group deal flow, diligence, and portfolio management.

    Thanks for writing on this topic.

    Reply
  2. Dave Avatar
    Dave

    Do it if you know the entrepreneur well and the industry but don’t just write checks and expect miracles. When doing this, be prepared to invest time too around your investment, be ready for a roller coaster and to lose everything. Most importantly don’t be afraid or stupid but understand the risk and use your information about the entrepreneur and industry to beat the odds. And, typically the easiest deals and those not needing the money are usually the best. So minimize your risk and be smart with who and what you invest in! In my opinion, I would rather do 2-3 deals where I have great insights than 20 relying on the odds which are not in your favor. As in life, nothing comes easy and especially when investing!

    Reply

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