84. How to start angel investing

Video version of “Get Started Angel Investing”

Angel investing can seem intimidating at first. This article will teach you a low-risk way to get started and how to maximize your long-term results.

I have been an active angel investor since 2012. I am on the board of directors of the local Angel Group, the North Bay Angels, and run their process for selecting the companies to present to the membership. I have looked at thousands of companies and invested in over thirty so far.

People choose to start angel investing for a multitude of reasons. Often angels are entrepreneurs with a recent exit who want to give back to the startup community and stay active in that world. Others are people who have built up a significant nest egg and want to diversify into early-stage companies. Most angels want to help the companies in which they invest, giving them some direct involvement and letting them share in the excitement of growing a company.

Go Slow

You may be tempted to invest in the first company you see. Resist that impulse! You don’t have enough experience to separate the good deals from the bad.

While it’s not impossible that the first company you consider is fantastic, it’s not likely. Angel investing is a long game, and succeeding requires a disciplined approach.

I recommend that you don’t make any angel investments in your first year. Look at as many deals as you can and analyze what makes some of them better than others. Once you have seen a few dozen pitches, you can start calibrating your judgment. You can’t know what a good deal looks like without seeing a pile of bad ones.

While you look at those first companies, start creating a shadow portfolio. Capture all the companies you examine and whether you would have invested in them. Then monitor them to see how they perform over the next year or two. You probably won’t see any exits, but you can see if they are growing or failing. Use that to refine your analysis.

Start Small

After that first year, when you start making investments, start small. Historically, the minimum angel investment was usually $25,000 and sometimes $100k or more. Fortunately, crowdfunding, syndicates, and SPV (special purpose vehicles) can let you start with much smaller investments. One reason to start small is you are still learning at this point.

The other reason for small investments is you will need to make a lot of them. Angel investing is a statistical game. Nobody has a surefire method for identifying which companies will succeed and which will fail. You need to take a statistical approach to your portfolio.

Most startups fail, so even with careful analysis and due diligence, most of your investments will fail. You need to find at least one big winner to compensate for all the losers. If you are careful in selecting deals, you should expect about 10% of your companies to generate substantial returns.

So, you need to invest in at least twenty startups to have a good chance of hitting that jackpot.

Select Your Target

Before you write your first check, think about your investment thesis. What kinds of companies do you want to back? You might look at focusing on one or more targets in some of the following categories.

• Industry: Medical, Financial, Educational, Agricultural, Manufacturing, Entertainment, …

• Technology: AI, Blockchain, Quantum, Solar, IoT, …

• Category: SaaS, B2B, B2C, Hardware, Food & Beverage, …

• Stage: idea, pre-seed, seed, Series A, …

Look for areas that excite you or where you have particular insight or expertise. I suggest focusing on pre-seed companies. They are past the idea stage but should still have low enough valuations for your small investment to generate meaningful returns.

Set a Budget

Create a budget for angel investing. Choose an amount you can afford to lose and are comfortable being locked up for years. I like to set an annual budget to ensure I can continue to invest year after year.

Some companies fail quickly, but success usually takes a long time. Few pre-seed companies exit within five years. My startup ran for thirteen years, so some of my investors had to wait more than a decade to see their returns.

Sticking with an investment budget can be challenging. I certainly have trouble sticking with mine. When I have already allocated my funds for the year, then encounter a very appealing deal, it is hard to walk away. But I do. If I start breaking this rule, it is a slippery slope that can lead to radically over-investing in this high-risk asset class.

Don’t Lead Rounds

Some founders may ask you to lead their round. Don’t do it, at least not for a long time. The lead investor is usually the largest. They negotiate the valuation and other investment terms. However, leading requires significant knowledge and experience. I wrote a whole article on some of the more problematic terms, and it just scratched the surface. Most angel investors never lead deals.

By following, you get to take advantage of the experience of the lead investor, who puts their reputation on the line and will negotiate for the best possible deal.

Often founders want you to lead the deal because they need someone to go first to get the fundraising ball rolling. Rather than lead, you can make a soft commitment to invest once they find a strong lead investor. That allows the founder to treat you as a “soft circle” so they can show fundraising momentum without putting you in an uncomfortable position.

After a few years, you will develop a strong intuition for which deals are worth deeper analysis, a robust investment thesis, and a process for analyzing potential investments.

In the next article in the series, I will look at how to find those deals in the first place.

Until next time, ciao!