It is a romantic idea to want to be an Angel…to be a patron of the startup, or as one of our members phrases it, “worshiping at the altar of capitalism.” Every day I hear about how much fun most people believe my job is because of the ability to work with passionate entrepreneurs to turn dreams into reality. And, you know what? It is fun! Most successful people I know say they want to become angel investors. But, not every qualified investor can or should be an Angel. And, I am tired of UNMAKING Angels!
It is no secret that Angel Investors, as an industry, enjoy better than market returns. According to the Kauffman Foundation, the industry average is 2.6x on your money in 3.4 years (individual results will vary widely…and we are about to talk about why!). Out of the 5 – 8 million qualified investors (according to the SEC regulations of $1M in networth excluding your primary residence or $200,000 in annual income), only approximately 320,000 individuals choose to do so (Angel Capital Association, 2016). That is a NOT a happy number! It amounts to between 4 and 6 % of those qualified, which is well below the “tipping point.” If the returns are so great, why aren’t the rest of the qualified individuals investing in the angel capital industry?
The answer is two-fold. First, angel investing is not easy. It takes work. It takes time. And, it takes dedication, participation, and collaboration. Second, it takes intestinal fortitude to weather the inevitable losses that come, typically, before the wins. Industry numbers on the process are intimidating. As an industry, Angels return capital from 6 out of 10 investments with one to two exiting companies paying for all the loses plus a healthy profit. In this model, 4 – 5 will be a total loss, 3 – 4 will be a modest return or loss, and the last 1 – 2 will be the ones that pay for the entire portfolio. Venture capital numbers are, not surprisingly, very similar. It is daunting to watch a great idea in the hands of a passionate entrepreneur crash and burn….and not just one, three to four of them! And, almost inevitably, the ones that return capital are the last to exit. As they say in the industry, the lemons ripen in two years, but the plums ripen in 4 – 7. So, it is not just one leap of faith. It is a series of leaps of faith in the face of statistically backed failure!
For this reason, the industry recommendation is to make 20 investments over 3 – 5 years to give the best odds of returning 2 – 3 times your capital (Rose, 2014). That sounds simple, but it is deceptively hard. We all want to believe we are smart enough to pick the winners, but that is hubris talking, not financial savvy. So, the first few loses are hard to swallow no matter how sophisticated an investor you are. And, there will always be one that will surprise you that you thought was as sure a bet as can be made. Luckily, that works both ways and one will almost certainly surprise you that you thought was a “walking-dead.”
Despite these recommendations, many new Angels want to stick a toe in the water to test it. I do not recommend this. Because, I believe this is the root of UNMAKING Angels. And, we are really good at it as an industry. The fastest way to lose at angel investing is to make two – three investments and then sit on the sidelines “to see how they perform.” Yet, this is exactly what many first-time angel do. They come in with the best of intentions, make two to three investments, and then decide to see how these first few work before proceeding. They have almost certainly nailed one foot to the track at the beginning of the marathon, and they don’t even know it. The likelihood of one of these three being the big home run is one in 10 if you believe the industry numbers, which are also subject to regional variation. And, they will have to wait up to seven years to find out if they hit the lottery or bought a losing ticket. Because they are not investing, they stop participating, lose interest, and slowly drift away. Finally, without meaningful exits quickly, they throw their hands up in the air and proclaim that angel investing is a bust. Thus, another Angel is UNMADE. It is a very, very common process. No matter how many times you tell someone not to fall into this trap, they do. I can’t describe how tired I am of UNMAKING Angels.
There are two types of investors, cowboys and players. Cowboys believe they know one or more industries well enough they can pick the winners, want to be seen socially as leaders, and are willing to make big bets on a few companies. In my experience, they tend to make more emotional decisions with less diligence and shirk off loses rather than admit they need to be part of a “village.” Conversely, players, recognize there is safety (wisdom and support!) in numbers. They recognize that leveraging the collective intelligence of a diverse group of professionals enhances your chances of making a great investment. They also realize that spreading the work of diligence across a network makes the work easier and very valuable due to different perspectives, knowledge, and experience. They sweat the loses, but have enough diversity in their portfolio that they should eventually come out on top. These are the true agents of change in a community – those willing to make a large number of small bets, participate in the company’s success, and celebrate their victories. They know they must be active investors and be involved in the company (Angel Capital Association, 2007). They share the load of being active investors. They understand the value of sharing knowledge and expertise to find and grow great opportunities.
Angel clubs (groups of independent angels that hand-select deals in which they will invest, i.e. the “pass the hat” model) tend to attract cowboys not players. But, there is a better way! I can tell you with our transition from the angel club model to the angel fund model in 2015, our deaflow has increased, our average investment has gone up, the quality of the companies coming through the funnel has increased, we invest in more and larger second/third round financings. Our members are involved in the companies’ daily lives and our network moves along at a healthy cadence. The fund model forces a certain amount of diversity on its members in a healthy way. And, it forces them to do the smart thing with regards to angel investing: set aside an amount of money and invest it in a minimum number of companies over a period of time. In general, that is $50,000 in 10 – 15 companies over 2 to three years. Some people will balk at the cost of forming a fund, but we have found over time, the cost is no different than joining an angel club. This is the recipe for angel investing success. Players are attracted to funds. They enjoy a unity of mission, purpose, and action. And, they remain engaged throughout the entire process.
So, here are the recommendations for MAKING good Angels:
- Plan to invest $50,000 – $500,000 over a 3 – 5 year period and invest in a minimum of 20 well researched, top-shelf deals.
- Find a like-minded group of people that you want to work with to identify and vet great opportunities.
- Perform a minimum of 20 meaningful hours of research on the team and company with a target of 50 spread across your group (the industry stats show these are critical breaking points for success). (Hudson, 2015)
- Invest in a diversity of markets based on the experts you can reach to assist you.
- Some of your investing should be hyperlocal to impact your community.
- Some of your investing should be regional as a rising tide lifts all ships.
- Hedge your bets by casting a wider net through angel fund “syndicates” or online platforms to ensure industry, market segment, and geographic diversity.
If you think you have what it takes to become a great Angel, please contact us. We will be happy to hear from you!
Copyright Angel Capital Group 2018
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Rose, David S., 2014 Angel Investing: The Gust Guide to Making Money & Having Fun Investing in Startups, https://www.wiley.com/en-us/Angel+Investing%3A+The+Gust+Guide+to+Making+Money+and+Having+Fun+Investing+in+Startups-p-9781118901212.
Angel Capital Association, 2016, Angel Investment in the US – Trends & Best Practices, http://angelcapitalassociation.org/data/Documents/ACAatAEBAN09-26-16.pdf
Angel Capital Association, 2007, Study, Returns to Angel Investors In Groups https://www.angelcapitalassociation.org/data/Documents/Resources/AngelGroupResarch/1d%20-%20Resources%20-%20Research/ACEF%20Angel%20Performance%20Project%2004.28.09.pdf
Hudson, Marianne, 2015, How much diligence does an angel really need to do? https://www.forbes.com/sites/mariannehudson/2015/01/15/how-much-due-diligence-does-an-angel-really-need-to-do/#4dd298fe4e0e