It seems that more people than ever are contemplating angel investing. This new wave of aspiring angels is debunking myths and misconceptions: from the minimum ticket size needed to start to the characteristics required to become a successful investor.
It’s easy to see the appeal of angel investing, particularly given the proliferation of startup success stories. It’s intellectually stimulating and can potentially be both financially rewarding and more purposeful than other asset classes. What’s much harder is to navigate its complexities and the associated risks.
While aspiring angels should not hesitate to bring a fresh perspective to the market, they might also find it useful to engage with more experienced angels and learn from some of their early mistakes.
One of the questions I like to ask the top-performing experienced angels I collaborate with is: “With the benefit of hindsight, what is one key thing you would have liked to know during the early days of your angel investing?”. Here are some of the recurring lessons they share.
It’s more about the people than it is about their initial ideas
Much has been written and said about the importance of the founding team. Still, I’ve come to believe that, when it relates to early-stage investing, it can’t be overstated. Time and time again, angel investors reach the same conclusion: the potential of the founders matters more than the potential of their initial idea.
“Just ask yourselves, is this person exceptional enough, particularly when looking at the CEO of a business. Sometimes I’ve invested in businesses where I thought the idea was great and I wasn’t sure about the CEO. Now if I were to go back again, I think I would apply my rule of investing in founders as opposed to investing in businesses even more fundamentally,” shares Chris Mairs CBE, Venture Partner at Entrepreneur First and prolific angel investor with more than 100 companies in his portfolio.
Ideas can’t be considered in isolation. As Simon Hulme, Programme Director of MSc Entrepreneurship at UCL School of Management and active angel investor, warns, “a great idea is simply useless in the wrong hands. I have made the mistake of assuming that entrepreneurs apply common sense to the running of their businesses. Not all do!”
Many experienced angels admit that they should have placed an even greater emphasis on the quality of the team and on the ways in which one could probe that early on.
“While I always knew that early-stage investing is very reliant on the strength of founders, with hindsight I would have gone even further in testing my judgment of founders,” reflects John Lazar CBE, Chair at Enza Capital and fellow of the Royal Academy of Engineering. “As an investor, you don’t just want your founders to be strong, you want them to be excellent – rare in their qualities – and if you have any doubts about their resilience, talent, ability to absorb feedback while sticking to their guns, understanding of the problem they are trying to solve, etc., then you shouldn’t invest.”
Be careful to not invest too much too fast
Give yourself time to get familiar with angel investing. There is no rush. In the beginning – particularly if you’re new to the world of startups – you might find yourself getting excited about most of the opportunities you come across and willing to invest relatively large amounts in each of the companies. While you may be eager to go up the learning curve, you can also do so by investing smaller amounts per company and pacing yourself along the way. Mistakes might be inevitable but they don’t have to be very expensive ones that quickly exhaust the capital you’re looking to allocate to angel investing.
“Because I had sold my business and had plenty of capital, I tended to invest too much in the first round. Combined with a lack of experience in selecting opportunities, this meant that I wasted a great deal of money in the early years,” warns Hulme.
Sophia Bendz, Partner at Cherry Ventures, has learned a similar lesson through her angel investing: “Don’t invest too much too soon, there will be more opportunities coming your way. I think I was very trigger happy in the beginning just out of pure excitement but, to be honest, you don’t need to do $50k tickets. It’s ok to start with smaller tickets and do a larger number of deals.” Bendz adds the caveat that the ticket sizes depend on how deep the pockets of aspiring investors are.
While there are no absolutes when it comes to ticket size, it’s worth adding that one of the biggest misconceptions around angel investing is that only ultra-high-net-worth individuals can consider it. In fact, smaller ticket sizes are not that uncommon and could well be part of viable angel investing strategies, especially when paired with a good value proposition to founders and a thought-through approach to portfolio construction.
Portfolio construction matters more than you might think
Some investors look at angel investing as a way to diversify their overall portfolio to include a high-risk, potentially high-return asset class. Zooming in, to mitigate some of the risks, a long-term angel investing strategy should also contain guidelines around portfolio construction.
Two key concepts to acknowledge are diversification – the number and types of companies that you’re looking to back – and follow-on – if, when and how much you’ll be investing in your portfolio companies in subsequent funding rounds.
In early-stage startup investing, the returns follow a power-law distribution, most of them coming from a small number of companies. A diversified portfolio can increase your mathematical chances of including a positive outlier.
“I was investing relatively high tickets in only two or three startups per year in the first years. Meanwhile, I learned that the probability of having outstanding startups in my portfolio (generating at least 20x multiples and allowing me to have a positive ROI in total) is much higher if I invest smaller ticket sizes in at least twenty startups per year. Angel investing is a high-risk and very long-term business, where I can hardly predict each investment outcome in 5 to 10 years. Still, I can mitigate this risk by building up a diversified and large portfolio generating an adequate number of extremely successful startups more than compensating the low performers and total losses that I would expect to see with at least 50% of my investments,” shares Andreas Mihalovits. Mihalovits has invested in more than 100 international startups and co-founded the Global Super Angels Club.
Think about how you want to allocate your money, not just across companies but also across funding rounds. Hulme details his approach: “As I became more experienced I invested modestly in the first round, and then only followed through if very positive progress had been made by the management team. This ’stop loss’ policy has been very effective at reducing downside. In following through I will also remain cautious, but may invest the same amount again, or up to double. Occasionally I have gone on to do three or four rounds, but generally stop at three as a maximum.” If you are considering investing in a company more than once, you have to, “set aside money so you can do follow-on investments in the ones that are performing well.”
Follow-on decisions are not without complexity, especially if you’re taking into account the opportunity cost of that capital – whether it would be put to better use in a different way.
“If the share price has moved up too quickly, it may not be worth taking part. I have, for example, got a scenario where a company that is currently progressing well is having a new round at 4x the original share price I paid. The outlook is extremely positive, with a Series A imminent at a further uplift, but I face the reality that the same investment again will double my initial exposure but only increase my final return by 25%. Maybe it would be better invested in a further early-stage business?” ponders Hulme.
Have realistic expectations around the timing and nature of exits
Angel investing is a long-term game. Setting secondary sales aside, it generally takes 7+ years for a major liquidity event – IPO or acquisition – to occur. There are examples of companies that grow much faster and get to that stage sooner but they are not the norm and they shouldn’t skew your expectations. Don’t invest capital you might need to access anytime soon or amounts that you can’t afford to lose.
“When I look back at the experience I’ve had over the last 10–12 years, the best businesses will take 10 to 15 years to grow to a sizeable exit. It’s possible to do it in 5 to 10 years. Sometimes it happens in 18 months or 2 years but it’s very rare that happens. You’ve got to think about a long timetable, it’s called patient capital for a reason.” highlights Simon Thorpe, Managing Partner at Delta2020 and Chair at Cambridge Angels. “Don’t sell too early because your best ones, your oranges, take longer to ripen than your lemons. You’ve got to stick with the oranges.”
Indeed, aspiring investors should be aware that the losses typically start coming up much earlier than the big wins. One of the first warning signs is when a portfolio company struggles to hit any significant milestones and fails to raise the financing it needs to grow further. At the earliest stages, the founders primarily sell a vision but later-stage investors expect to see compelling results. Of course, successfully raising further financing doesn’t guarantee a good exit – there are many instances when failure to scale only becomes apparent after multiple funding rounds. Companies being cash flow positive and not needing to raise further capital is also not indicative of an upcoming exit.
Have the courage to use your knowledge and convictions
There’s no denying that it takes time to become comfortable with angel investing and that there are still many barriers that could prevent you from doing so: from lack of capital to lack of network. If the absence of a relevant network is what prevents you from starting, you may want to consider joining an angel network/syndicate or even investing in an early-stage fund. Still, starting anything new can be hard. Angel investing is no exception.
“If I could go back in time, I would have told myself that my input is useful. When I start anything new, I lack confidence in my understanding and ability to contribute effectively. You need to have a little bit more courage of your knowledge, experience and convictions. At the end of the day, angel investing is partly investing that knowledge and experience in assessing and supporting a business,” shares Ros Singleton, CEO of Spring Fibre and Chair of UK5G. Kirsten Connell, Venture Partner at Octopus Ventures, agrees: “Having conviction and trusting your instincts is key.”
Your knowledge and convictions are assets that you can use to identify hidden gems, before they may become obvious opportunities to others in the investment community.
Clarify your value proposition to founders
Meeting promising founders, having capital available and deciding if and how much you would like to commit to a funding round are all part of being an angel investor. They are necessary but not sufficient. The missing piece is for the founders themselves to be willing to welcome you on board. The founders that are being perceived as high-potential are often faced with oversubscribed funding rounds and have to select which investors receive an allocation and which do not. Aspiring angels should think holistically about their value proposition to founders and be prepared to articulate it clearly. I wrote more about it here.