Is Angel Investing Right For You?

Everyone knows that angel investing is risky, but the mind-boggling returns continue to attract new investors hoping to cash in on the next big thing. It takes a certain personality type to embrace the rollercoaster ride that is angel investing. These investors are realists, fully understanding the slim odds of success, yet at the same time, wholehearted optimists, believing that they could be the ones to discover the big win.

Readbelow to see whether angel investing is a good fit for your personality, orwhether you should stick to other asset classes.

 

Are you willing to take the risk?

It seems as though every day we readabout another startup exit. Techcrunch and Venturebeat are flooded with the successstories that stir up jealousy in all of us. The twenty something year old entrepreneurwho just raised seed funding and already sold his company for hundreds ofmillions. And let’s not forget the angel investor who recognized the potential
and made the investment of his life.

It is easy to get excited by these
stories, but the harsh reality is much different. According to the National Venture
Capital Association, 25% to 30% of venture backed businesses fail. However,
according to Shikhar Ghosh, a senior lecturer at Harvard Business
School, the venture capitalists “bury their dead very quietly. They emphasize
the success but they don’t talk about the failures at all.” According to
Ghosh’s research, about 75% of all VC backed firms in the US don’t return
investor capital. It is important to note that this research is just for VC
backed firms, and the reality is even harsher when taking into account all
startups.

As
angel investing is very risky and the chance of success is pretty low, it is
recommended to only risk a percentage of your portfolio that you wouldn’t mind
losing- usually 1-5% of your net worth. Assume that most of the investments
will fail, and hopefully a few big wins will make up for the losses.

This
mentality is explained by Dave Berkus, a California based entrepreneur who
had a number of exits in companies that he invested in. Of the 108 deals that
he made since 1993, 26 companies have gone bankrupt and 50 are unlikely to ever
be sold. “Ninety percent of the money I ever made as an angel investor came
from four investments,” Mr. Berkus said. “It’s the gambler’s mentality
mitigated by the ability to select intelligently.”

 

Are you good at identifying the next big
thing before it is big?

As
an angel, you need to be able to pick the high potential startups. The ins and
outs of angel investing are explained by Paul Graham, programmer and venture
capitalist, who co-founded Viaweb (which later on became the Yahoo store) and Y
Combinator. In his blog post “How to be an angel investor,” Graham explains that the trick to
being a good angel investor is all about knowing how to pick the startups that
will make something that will be really popular, before they do so.

According
to Graham, “To be a good angel investor, you have to be a good judge of
potential. That’s what it comes down to. VCs can be fast followers. Most of
them don’t try to predict what will win. They just try to notice quickly when
something already is winning. But angels have to be able to predict.”

In
addition to identifying strong ideas, a good angel investor has to be able to
identify a successful entrepreneur. This is often times more important than
being familiar with the industry, term sheets or valuations. As is often said, the
people are what makes or breaks the company. According to Graham, you must
identify founders that are “relentlessly resourceful.” What does this mean? He
explains that it is the “opposite of hapless. Bad founders seem hapless. They
may be smart, or not, but somehow events overwhelm them and they get
discouraged and give up. Good founders make things happen the way they want.
Which is not to say they force things to happen in a predefined way. Good
founders have a healthy respect for reality. But they are relentlessly
resourceful.”

 

Do you have the patience to wait?

When
investing in early stage startups, it can take years until a liquidity event
can materialize. According to CB Insights, in 2007 it took a company 70 months to
get from the first funding round to IPO and 59 months to an M&A. In the
past couple of years, the time to IPO has increased year over year, but the
time to M&A has remained largely constant.

 

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Successful
angel investors will tell you that patience is key, and early stage investments
are a marathon race with winners identified in the long term.

Ron
Conway, founder of SV Angel and the “godfather of Silicon Valley”, has invested
small sums in over 600 early stage startups since the 1990s. This includes an
investment in Google in 1999, before the search engine became the market leader
that it is today. He has had his share of disappointments, with hundreds of companies
shutting down. However, he knows that this is a long-distance race and has the
patience necessary, waiting years until his early stage investments in Twitter,
Square, Dropbox and Airbnb built billion dollar enterprises.

 

Shelly Hod Moyal

Founding Partner, iAngels