To Be an Angel Investor Is Easier Than You Think
To Be an Angel Investor Is Easier Than You Think
The good news is that you don’t need to be a millionaire to become a business angel, but there are a lot to learn.
Here is what you should learn.
1. You must not start Big
It can be tempting to throw money at every pitch deck that you receive. There are tons of Start-ups looking for funding every day, in every sector and country on the planet. While everybody talks about the insane multiples achieved by early investors in unicorns like Uber (>2500x), nobody talks about the failures. There is a very high probability that 9 companies out of 10 in your portfolio will eventually fail or barely break-even.
Hence, I strongly advise you to take a very careful approach by first investing relatively small amounts ($6000). This will allow you to invest in different companies and climb up the (steep) learning curve of angel investing.
It is important to understand that anything below $6000 might prevent you from entering most rounds. Crowded cap tables with lots of small shareholders can be difficult to manage for founders. VCs are also not very fond of this.
Don’t forget that there is a very high chance that you will never see the money you invested in these startups again. You have to be able to stomach this.
Be patient, and once you feel comfortable, increase your ticket size. Don’t FOMO, tech is not going away, so there will be plenty of opportunities around once you feel ready. I started too big too early, and have now significantly reduced my ticket size.
2. Count on your peculiarity
A very experienced business angel who lived through the dotcom boom and successfully sold his startup told me one of the most important pieces of advice.
Before you start deciding on the themes you want to invest in, know what you don’t want to touch.
This is key because it will give you more headroom to focus on where you are good at. I decided to exclude social and mobile games because I never really understood the dynamics that were driving these markets. I now feel comfortable passing on these investment opportunities.
On the other hand, you also need to specialize to develop an edge. Use your own experience for that. I worked in Mobility for 4 years, so I had spent a lot of time experiencing first hand what works and what doesn't. Use this proprietary knowledge and leverage it, it will allow you to eventually score your biggest wins.
3. Make your vision and work on it.
Since there is an endless stream of companies looking for funding, I felt overwhelmed at first. How was I suppose to make decisions with this amount of decks to review? Would I eventually FOMO? It quickly became apparent to me that I needed to put a rating system in place to filter out the most promising ones. Most top VCs invest in <1% of the pitch decks they see, and “no” is their standard answer. I decided to apply the same rigor to my approach and build a model.
I used the factors listed as decisive by Peter Thiel in his classic Zero to One and added my touch to it. Companies are rated from 0 to 5 on every factor, and those with a score below 70 are automatically eliminated. I review those with a score above in detail and if they are promising, I meet with the founders.
A simple yet efficient way to filter deals.
It also allows me to keep track of all my decisions and get back to them later. In a few years, I might find out that I passed on a Unicorn. But at least, I’ll know why, and I’ll be able to adapt my ratings if necessary. Then I’ll go crying.
You might be perceived as a small fish in a big pond with $6000 tickets and little experience in angel investing, but this doesn’t mean you won’t be able to access good deals. You need to differentiate yourself by offering something most big business angels don’t have: time. If you are a product manager, offer the startup to help them on their roadmap. If you have expertise in growth, assist them in building out their acquisition channels.
Compensate the fact that you will not invest a high $ amount by adding value to the business and by being hands-on, for free. You would be surprised how often this will get you through the door. This will not only be very appreciated by founders but it also allows you to hedge your bets by being active.
Be good, be helpful, and open your network.
Make sure to take important aspects into account: raising funds is time-consuming. It often prevents founders from focusing on their core tasks, i.e. growing their company. Be a good BA and say yes or no quickly, ideally not more than 2 days after you talked to them. Your reputation matters.
To invest in the best startups, you have to have access to the best opportunities. While there is an endless flow of pitch decks flying your way, many of them aren’t very interesting. Getting access to the best startups without being a renowned business angel (i.e. mostly successful founders) can be tough. So, as Paul Graham said: do things that don’t scale.
· Screen companies: Subscribe to newsletters in the sectors that interest you the most. Follow the founders of companies that inspire you on Twitter. Set Google alerts on funding. Install the Kima plugin to see their latest deals.
· Cold email Founders: Once you found a promising company, email their founders and give them feedback on their product, be useful. Once they start raising funds, they will remember you.
· Leverage your Network: Ask people around you if they recently tested cool new products. You will be surprised to see how many good leads you will get.
· Build your brand as a Business Angel: Write about it (yes, this medium post falls in this category), Tweet about it, talk about it. Make sure people are aware that you are active. Start generating inbound leads.
· Try Crowdfunding: Did you know that Revolut or Monzo, which are now worth Unicorns, went through multiple rounds of Crowdfunding? The biggest platforms in Europe are Crowdcube or Seedrs. These platforms are great to get dealflow, but be extra careful when reviewing pitch decks, the overall quality tends to be low these days.
· Join a syndicate or a Business Angel Club: Let others do the heavy lifting for you. Bear in mind that some of these clubs/syndicates charge annual fees or require a minimum amount invested.
If you spent a bit of time thinking about your overall investment strategy, you might have heard about Markowitz’s modern portfolio theory. One of its key findings is that diversification reduces risk while allowing you to secure the optimal return. In other words, you don’t put your eggs into one basket. The same applies to startup investments.
This chart tells one thing: the more companies you own in your portfolio, the more likely you are to generate a profit. With only 5 companies in your portfolio, you only have only a 50% chance of making your money back. Many angel investors consider 15 to 30 holdings as the sweet spot. On the other hand, having a concentrated portfolio could become hugely profitable if you have a winner in it. But it’s more of a gamble.
Aim for a number of holdings that match your resources. If you want to invest $30000 per year, and your ticket size $6000, you should end up with 15 holdings.
This leads me to another brilliant insight I learned from a veteran investor: startup investments are like wine vintages. Some years are exceptional, and even startups that you weren’t so sure about end up becoming a success. And other years are complete disasters, and all startups go bust. To avoid this, invest in at least 3 different vintages!
My gut feeling tells me that startups raising in 2020, amid a global pandemic, will have a very higher chance of succeeding! Valuations are becoming more reasonable, startups focus on profitability and are frugal when it comes to spending. Now is the time to be aggressive and scout for the best deals.
7. Master your principles
Funding rounds are complex. There is a lot of legal paperwork involved, the terms can be difficult to understand and it’s full of idiosyncratic jargon. Make sure you understand what you are getting yourself into before committing a single €.
Educate yourself about term sheets, valuations, share types, liquidity preferences, etc. There are many great resources out there:
· Ultimate Start-up Funding Guide by Crunchbase
· YC guide about raising a Series A
· Term Sheet by the Galion Project (French)
You might also want to ask a lawyer about the tax implication your investments can have. Be prepared.
8. Double down on the champion
Investing in early-stage startups is a risky business, and there are high chances that most of your companies will go bust or barely break even. However, if you have the chance to own shares in a company that proves to be a success, double down on them by investing in subsequent rounds. This increases the size of this holding in your portfolio and will mechanically reduce the overall risk of your portfolio.
This approach is called “follow-on” and is actively used by VCs. Wondering why? Let’s listen to what Marc Andreesen said, founder of Netscape and one of the most successful VC firms, a16z:
The key characteristic of venture capital is that returns are a power-law distribution. So, the basic math component is that there are about 4,000 startups a year that are founded in the technology industry which would like to raise venture capital and we can invest in about 20.” “We see about 3,000 inbound referred opportunities per year we narrow that down to a couple hundred that are taken particularly seriously… There are about 200 of these startups a year that are fundable by top VCs. … about 15 of those will generate 95% of all the economic returns … even the top VCs write off half their deals.
In other words, these winners will pay for all the failures in your portfolio, and they’ll generate a profit on top. If you don’t take advantage of the power-law and aren’t ready to double down on your outliers, you’ll miss out on most of the opportunities.
To avoid dilution and protect your line, you need to double down. This means that most of your capital will eventually flow into these follow-on investments. Make sure to have a buffer to react quickly.
Even though everybody thinks they have an edge on other investors, they probably don’t. Unfortunately, both you and I will likely lose 9 out of 10 bets. If the remaining one is the next Zoom, then we will be doing great. Otherwise, we might end up losing money. Some VCs believe most angel investors will end up with a negative IRR on their portfolio. The good news is that most VCs do as well.
Although I’d rather avoid ending up in this situation, I would not regret the investments I made because they allowed me to learn invaluable lessons. If I became a better investor, it’s by actually putting my money where my mouth is. Nothing replaces learning by doing.
However, angel investing should NOT be the backbone of your overall financial strategy. Allocate only a small portion of your net asset (5 to 10%) to these bets, and put the rest of your money in less risky assets like equity and bonds. Best of Luck!
