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?