In my previous article, I outlined what angel investing is, how investments work, and how you can get started.
In this article, I will discuss things in more detail, will provide you with tips and advice on how to make the most of your angel investments.
Tip 1: Decide on your strategy before you start investing
As an angel investor, you need a plan and strategy before you make your first investment. It doesn’t need to be overly complicated, but it should cover some of the basics. It should mention things like:
- Time commitment: how much time do you have available to invest in angel investing? Are you going to be hands-on or very much an armchair investor?
- Investment strategy: are you going to focus on a particular industry, technology or functional area?
- Deal sourcing: how you will generate deals? Are you going to source them directly or use a syndicated approach where you can piggyback off other people’s deals?
- The amount you will invest: how much angel capital are you going to put in and over what period? Are you going to keep any capital back for follow on rounds?
- Deal size: do you want to aim for larger deals where you are the main investor or smaller deal sizes where you co-invest with other investors?
- Portfolio diversification: how many deals do you want to make with your available capital? A minimum of 10 deals is advisable for adequate portfolio diversification.
Tip 2: Have a clear and documented screening process
If you are successful then a lot of potential deals are going to come your way. Problem is, the number of pitch decks that you are sent and the volume of people trying to pitch you can be incredibly overwhelming.
If you don’t have a clear and documented screening process then you are going to drown in pitches, and you might miss out on a winner.
The best way to go about a screening process is to have an initial filter. When offered a new opportunity, ask yourself:
- Can I add value to this company?
- Does it align with my focus areas of investment?
- Is there a clear right to win?
- Do I believe in the founding team?
- Does my gut tell me this is going to be a winner?
I know that unless I am being pitched an investment with a strong technology angle, with a business that will have a big positive impact on the world then I politely decline to go any further.
For those investments that pass the initial filter, you will want to do a lot of in-depth research, diligence and interviews with the founding team.
I will discuss how to filter potential investments in a future article.
Tip 3: Invest alongside other angel investors
It can be a lot more fun investing with other like-minded investors, and there can be a lot of other benefits to building your investment network.
Joining an angel syndicate or finding angel groups will allow you to co-invest and learn alongside people who are experienced in the field. I learned a lot by being around active angel investing experts who I could ask questions to, and they helped me better understand their investment approach.
It’s also beneficial to have a different perspective when evaluating startups. You can use these as an opportunity to help shape or challenge your thinking.
Finally, co-investing with other angels allows you to share the financial risk so that you are not on the hook for 100% of the investment. This is especially beneficial if you do not have a lot of capital to invest at the start of your angel investing journey.
Tip 4: Back the founder, not the business
Having a great founder and founding team could make all the biggest difference between success and failure for early-stage companies. Because of that, you are investing in the founder as much as you are in the company.
Assessing the founding team will be a large part of your investment screening process. Here are some things to look for:
1. Strong Character
Look for founders that have a real passion and drive for their business. Leaders with this trait are prepared to make tough decisions, and keep moving forward in trying times.
2. Commercially-aware
Being focused on driving the key metrics of the business and having a clear go-to-market are essential traits that the best founders carry.
3. Related experience or track record
Founders that have strong experience in their business area or industry tend to achieve the best results. So look at their previous ventures and how successful they were before deciding.
Tip 5: Find startups that will gain traction quickly
There are many successful early-stage businesses that have grown to huge scale without making a profit (Facebook and Amazon, for example). But this style of growth is beyond most angel investors, because of the cash and the depth of pocket required.
It is much more sustainable to work with a business that becomes self-funded early on. If you can demonstrate that the company is profitable then you are much more likely to get a strong valuation, all other factors being equal.
A Pegasus startup is one that is so profitable that it can use its profits to fund the business, so that it can skip one or more rounds of funding.
This is a huge advantage for investors because you will be diluted a lot less and the chances of a larger valuation when you do need finance is much higher.
Of course, this is much easier said than done!
Tip 6: Ignore financial projections for pre-revenue startups
In my opinion, knowing the size of the total and addressable market has very little value for angel investors. Almost any company can deliver a great return in almost any market segment when you invest early.
The financial projections for a pre-revenue, pre-product company are not worth the paper they are written on. There are so many variables to forecast that the projections are likely to be orders of magnitude wrong.
The only exception to this is when an early-stage company has a product and revenue and is already in the market. At that point then financial plans are a lot more useful.
It’s far more important that you have faith that the founding team know how to sell and have a clear vision for how they will take their product to market.
Tip 7: Only invest in businesses you can add huge value to
You need to pick businesses that your angel funding, and more importantly your experience, can add value too. This could be through your skills, networks or business development.
I’m a technologist, so I tend to invest in companies that have a heavy technology and software proposition. In this way, I can act as a technology advisor to the company, and I have a network that could help with the first few lighthouse clients.
This can also save you a lot of time having to learn about a new industry or new area for each investment.
It also helps your deal flow if investors and entrepreneurs know that you are the go-to person for a particular industry or area. If you can build a personal brand in a specific area then you are far more likely to attract strong deals.
Tip 8: Hustle for your angel investments
The majority of angel investors cut a cheque and then dedicate time to helping their business succeed. I have met angel investors who have dozens of investments and never call any of them, ever.
“The difference between Chris Sacca and a dentist who writes seed stage checks is measured in light-years. Someone like Chris Sacca hustles on behalf of the portfolio company, has the judgment and a network of people who know how to get things done.” – Tren Griffin
A big part of your role as an angel investor is to help your investment succeed. You cannot do this on the sidelines by attending a meeting once a quarter.
You should be using your expertise, contacts, experience and brainpower to help the founding team get traction and succeed. Unless you are a full-time angel investor, you cannot spend all of your time doing this, but you should spend a good chunk of time per month with your portfolio.
Tip 9: Double down on the winners
Angel investing is a very risky asset class. Therefore you must make the most of your winners by doubling down on them.
Make sure you use your angel funds to join the follow on rounds for the rare investments that are growing geometrically in terms of users and revenue. This is where the best angel investors make their money.
Spotting the emergence of a potential unicorn causes the best angel investors and venture capital firms to double, triple or more down on their best bets.
It is hard to predict and spot which investments will succeed at the beginning. That is why you should make a large number of small investments to see which ones start to show potential. You can then put larger amounts of “smart” money into the winners as they begin to gain traction.
This only works to a point, as at some stage angel investors cannot afford to keep putting endless cash into high valuation companies. This where venture capital firms have a much bigger advantage. The flip side of this is that it is equally important you cut the losers from your portfolio. You do not want to waste valuable capital in companies that do not have a successful future.
Tip 10: Place enough bets to win big
Massive wins in angel investing are rare, as we have talked about before, the majority of your returns are going to come from a very small number of investments. To give yourself the chance of hitting a home-run investment, you need to place a lot of bets.
Of course, you need to be able to screen and pick great companies, you need to work hard to help them succeed and you need to double down on your best companies. These are all very important factors.
However, the biggest factor influencing your odds of success, is giving yourself enough chances to find the winning needle in the haystack.
Being good at picking great companies is important, helping your companies succeed is important, and following on in your early breakouts is important, but at the end of the day, the most influential factor is having enough mathematical chances to even be in a big winner at all.
The best angel investors agree that the minimum number of investments should be 10, but the data shows that the median returns improve materially if you have a larger portfolio size.
Tip 11: Exit partially every couple of rounds
It can be sensible to exit every couple of rounds rather than ride the bus to the end of the line. This is what Jason Calanis calls “idiot insurance”.
If you believe you have backed a once in a lifetime unicorn then I would not advise this.
If you look at the stats, you will see many startups get to series A but never really make it to the big exit of IPO or mega trade sale.
As an angel, your limited capital means you can’t invest like a Venture Capital firm (with a 10-year investment timeframe) and keep making huge investments into every round. What you should do is liquidate and lock in your gains, by selling small stakes every couple of rounds. This way you can make some money off the table before the table disappears!
If you invest $10k at $1M into a startup that raises a Series A round at $10M, selling half your shares will net you $50k (discounted to 50% with dilution + terms). And you still have half of your shares left in the business as upside!
Summary
Angel Investing is high risk, high reward. You only need one investment to pay off to be a winner. That’s why you should make lots of small bets, to increase your odds.
If you’re considering investing, here are some tips to follow:
- Decide on your strategy before you start investing. Get a clear understanding of the basics, such as your time commitments and strategy.
- Before you take on clients or start investing, have a clear and rigorous screening process to avoid wasting your time and money.
- Find businesses that will gain traction quickly.
- Ignore financial projections. There are a variety of variables at play, and forecasts are rarely good predictors of success.
- Hustle and invest your time to try and add value to the businesses you invest in.
- Place big enough investments to win. Although placing lots of small bets is great, when a winner comes in, you need a big enough stake to benefit from the risks. Try and spot potential in companies early on, and invest more in those.
In following these steps, you are increasing your chances of finding a winner as an angel investor.