Last week I was talking to a potential angel investor and he was asking a number of questions. My first comment to him was how it’s dramatically more difficult than it seems. Yes, it’s easy to write a check. No, it’s not easy to be good at it and/or make money at it. As with anything, there’s a tremendous amount of survivorship bias. People only talk about the winners and rarely talk about the losers. And, most investments don’t work out (the loser investment bucket overfloweth with non-existent startups).
Thinking more about it, here are seven lessons learned from 15 years of angel investing.
Every Deal Looks Great at Time of Investing
When an angel investment is doing well people like to ask, “What did you see in the opportunity?” Of course, it’s always a great team, TAM (total addressable market), and timing. Only, every consummated investment is believed to have those. When making an investment, it’s hard to tell which one is actually going to succeed.
Winners Take Time, Losers Lose Fast
One observation I didn’t expect is that winners cruise along with the usual ups and downs, but don’t die, and then eventually something clicks where growth takes off. For the ones that don’t work out, it’s obvious right away, usually within 3-6 months. They don’t close down that fast, rather they flounder and don’t show authentic signs of forward progress.
Find a Lead Angel Investor
Someone has to care and want to help the entrepreneurs. Today, it’s far too common to have a big party round with dozens of investors putting relatively small amounts of money in the round such that no one takes the lead. Signs of a lead investor include issuing a term sheet (not a SAFE/convertible note), joining the board, holding a weekly call with the entrepreneur, etc. Startups are messy and complicated, even more so for first-time founders. Someone needs to step up and pro-actively help the entrepreneur.
Ask Why You’re Getting a Look at this Deal
When a deal falls in the lap of a potential angel investor, the very first questions that should be asked is, “Why am I getting the chance to see this amazing investment opportunity?” Rarely is the answer the investor tells him or herself a good one. In reality, it’s likely been looked at by professional investors and people with relevant expertise such that they’ve passed on it. Go seek the professional investors and ask why they passed before writing your own check.
Think Investing in a Minimum of 20 Startups
An old startup adage that’s incorrect goes something like this: out of 10 investments, one makes a ton of money, 2-3 make some money, and most lose some or all the money. I don’t believe this is true. I actually think the odds are dramatically worse. At a minimum, if angel investing for a financial return, plan on 20+ investments and budget appropriately. Maybe, if all goes well, one out of the 20 will be a homerun and return 50x+ while most will not be successful. Investing in five or 10 startups isn’t enough. Plan accordingly.
Reserve 4x+ in Follow-On Capital for the Winners
When a startup does well it almost always raises more capital, and in today’s world, significantly more capital. As an angel investor, the best investment is always doubling down on the winners by investing more capital in subsequent rounds. Put another way, instead of planning on investing in 20+ startups, plan on investing in however many startups it takes to get a homerun, and once you have a homerun, stop investing in new ones and put everything you can into the winner. Startups are power laws where the winnings are so massive that they make up for all the losses. Plan for investing at least four times more than the original investment in the outliers.
Expect 10 Years to See a Return
After 15 years of angel investing I’ve invested in 50+ companies and it takes significantly longer than expected to see financial returns. Ones that are doing well readily show strong returns on paper, but converting those paper returns to cash returns is a different story. Plan for a minimum of seven years to see financial returns for the ones that do well and expect it to often take 10+ years. And, for the ones that are doing well, there’s a conundrum that you typically have the opportunity to sell early because there’s strong demand from new/existing investors, but know that even greater returns often accrue in the later years as the business is growing fast at scale.
Angel investing is a strange activity that’s equally fun and energizing while most likely not financially rational without a unique edge. As an investment strategy, it should be viewed as part giving back (charity work) and part paying it forward recognizing the success in life that afforded you the opportunity. Regardless, go into angel investing eyes wide open knowing that it’s much more challenging than it looks. Good luck!