Where (and How) Angels Tread
Tips for aspiring angel investors from one of India’s leading early-stage angels
[Source: Pasadena Angels]
With public equity markets in turmoil, several are looking to rebalance their investment portfolios and diversify into other asset classes. One such asset class is angel investing. In 2020, angels invested over $25 billion in early-stage companies, pooling together $200,000 to $400,000 per deal.
Who can be an angel investor?
Angels, as the name suggests, are high-risk, high-reward private investors who swoop in with a lifeline to young startups usually before institutional investors do. Apart from infusing capital in return for equity, angel investors also contribute their experience, skills, and expertise to fledgling entrepreneurs in the hope that their involvement will positively influence the startup’s success. That might partly explain why startups receiving angel investments are 20-25% more likely to survive after four years and 16-19% percent more likely to grow to 75 employees.
While angel investors typically deviate from the traditional early-stage investor profile (i.e., the rarefied old boys’ club that is venture capital), they do share some attributes:
Access to capital
While there isn’t a minimum or standard amount, the average angel investment is $77,000 with typical amounts invested ranging from $10,000 and $500,000. Further, given the significant risk, this asset class usually constitutes a small percentage (typically 10%) of one’s investment portfolio. While accreditation is not a prerequisite for angel investing, several angel investors meet the SEC’s “Accredited Investors” standard (i.e., they have a yearly income of at least $200K, a net worth of at least $1 million, or an LLC or Trust worth over $5 million).
Access to high-quality dealflow
Angel investing is much more about not missing the big winners than it is about avoiding losers. Naturally then, swimming in a pool of multiple robust opportunities is half the battle won as an angel investor. Some angels increase their deal flow through their own particular domain expertise - perhaps they hail from a specific industry or sector themselves, or have a functional skill set (e.g., marketing expertise, or deep sales relationships) that fledgling founders would benefit from. Others increase their deal flow by building relationships with other active investors. Either way, this robust deal pipeline not only provides access to more investment opportunities, but also hones one’s ability to separate high quality deals from the rest when one sees them.
Patience
Angels are prepared to take a really long-term view and enter this asset class with the mindset that, in the worst case scenario, they can afford to lose all the money they put into their angel investments. Even if they reap returns on their investments, angels typically wait 10-15 years before they can cash out at the company’s first (or next) liquidity event. The best angels plan around their investments’ illiquidity in the short to medium term, and focus instead on helping their portfolio ventures reach their full potential.
How do you begin building an angel investment portfolio?
The prospect of growing small businesses while diversifying your investment portfolio might excite you, but it can be difficult to get started as a new angel.
I chatted with Siddharth Ladsariya about how to dip one’s toes in these waters as a newbie angel that’s just starting out. Since 2009, Siddharth has angel invested in over 110 companies, including unicorns such as Oyo Rooms, Myntra, Exotel, Uniphore, Fareye, and Greendust. He also turned a founder himself in 2016 with the creation of Everest Fleet, a fleet management company that owns and operates over 1000+ taxis in Mumbai and Bangalore. While he’s been very active in the entrepreneurial ecosystem with things largely headed in the right direction, his most important resource is the trove of first-party data to learn from.
1. Know exactly what you’re willing to put into it and what you’re hoping to get out of it.
When you’re starting out as an angel investor, knowing what you’re willing to put into the process will help you develop a brand and give startups a reason to pick you over other investors. This could take many shapes and forms; for example, you could be looking to contribute as a:
Subject matter expert:
Research shows that startups whose investors had relevant industry expertise had exits that were three times higher than the companies whose investors didn’t have that kind of expertise. For example, you could be a technical expert with a background that will help with upcoming feature development on the product roadmap, or a growth strategy expert with previous marketing and sales experience that would help scale day-to-day operations, or simply a mentor or advisor that can act as a sounding board for founders to make astute business decisions or help them raise funding. As Siddharth started building the pattern recognition muscle across his multiple angel investments, founders often turned to him for advice on fundraising.
Connector:
You could live in the Bay Area or Bangalore and have deep ties to a thriving startup ecosystem that will help founders connect with other key players or find the right talent for their companies.
Passive angel:
You could have surplus capital to angel invest, bring that money to the table and let the founders figure out how best to allocate their seed capital instead of being overly hands-on or disruptive.
Knowing where your unique profile falls on this spectrum as a new angel investor will help you identify opportunities that you are best aligned with. The inherent supply-demand built into markets typically ensures that there are founders on the other side of the table who share your values and approach to business given where they are at in their current trajectory.
Alongside the time and the unique network, skills and experience that you might bring to the table, having a clear sense of the capital you are willing to deploy each year into startups is crucial. Regardless of what your calculus is, you do not want to make an angel investment with money that you need in your three to six-month cash-saving buffer.
2. Get help, and help if you can, to establish your deal flow.
As an angel just starting out, it is valuable to collaborate early and often to start developing the access and astute pattern recognition skills needed to build a solid deal pipeline. There are multiple ways to start spreading your wings as a collaborative angel:
Mentor at an startup accelerator or incubator on a volunteer basis, or join an advisory board, even before you’re ready to start making financial commitments as an angel.
This will not only help you demonstrate your non-financial, strategic value add to a startup but also offer benchmarks in terms of different teams, ideas and approaches employed by early-stage startups.
Co-invest with other more experienced angels once you’re ready to actually get started.
Initially “copying the experts” could be through joining an angel group or investing alongside experienced friends and groups you trust and whose sector interests are similar to yours. Bouncing questions off of other angels looking at the same deals, and investing collectively means you can make more of an impact on a funding round.
Ask a founder if he/she wants to keep the round confidential or is looking for more angels to come onboard when you decide to invest in a startup.
The habit of sending a regular email to one’s angel friends sharing the deals one is looking at/investing in (sharing the URLs and a short blurb about the prospective company if one does not have permission to share their entire deck) can yield rich dividends if startups one is interested in are looking for more investors. Sharing great deals with other angels encourages them to do the same with you.
3. Understand the risks and manage expectations when assessing prospective deals.
Most would-be angels are familiar with the golden maxims of angel investing to manage risk:
“Two heads are better than one” (when it comes to making investing decisions),
“Invest in people, not the ideas”, and
“Diversify for better returns”.
But there are addendums to each of these maxims that newbie angels would be wise to consider.
While angels are stronger in flocks, that does not diminish the need to do your own research.
Regardless of who else is investing in a company, it should fit your personal thesis (stage, sector, price, etc.). Especially with angel investments, a big part of the analysis should be evaluating the strength of the founding team.
Evaluating the founder(s) goes beyond the proverbial “look for raw smarts, passion and integrity”.
In order to translate a great idea into a viable business while dealing with inevitable speed bumps along the way, it is important to avoid getting tied up in the founder's story, good intentions and their passion for the idea. Gauging whether the founding team has the right ingredients to succeed entails taking a closer look at certain parameters:
The founding team should be the right size. Being the sole founder can be challenging. It helps to have a thought partner to bounce ideas off, and to lean on because life as a solo entrepreneur can get very tough and lonely. Too many founders make for an unstable configuration too (you can’t have five cooks in the kitchen). Precedents (Steve Jobs and Wozniak at Apple, Bill Gates and Paul Allen at Microsoft, Larry Page and Sergey Brin at Google) suggest that the optimal founder configuration is two to three. It is more often the case than not that angels make funding contingent on a solo founder finding a co-founder to balance out the leadership team.
They should have the requisite skill sets to tap into a promising market with a solid differentiated product on offer. At the angel stage, founding teams likely have very limited financial records for a prospective investor to evaluate. Thus, it is even more important to be walked through the product to assess whether the founders can precisely define the specific use-case based on their first-hand knowledge of the problem (and not just their hypothesis of the problem) and execute on the product design without major unforced errors. However, in addition to evaluating the founding team for the “builder” mentality, it is equally important to evaluate them for the “seller” mindset. A critical element to establishing early product-market fit is having founders who can convince employees, customers and investors to sign up early in its fledgling state.
Founders should act in line with the “affordable loss” principle. The best investments are made with founders who minimize downside and get things done with the fewest necessary resources. Good rules of thumb to assess whether founders have this ethos include looking for a reasonable salary bill and an expected runway of 18+ months.
Even before getting in, you should have a line of sight for how you will get out.
Angel investing ends up being much like a Keynesian beauty contest, where you pick the winner (i.e., the most beautiful startup that you invest in) based on who you think the judges (i.e., institutional investors) will pick in the latter rounds. Your exit strategy (i.e., how you are going to get your money back) depends on fundamental analysis of the company, of course, but it’s also important to make sure your bases are covered (for example, do not do deals with convertibles, look for red flags in deal terms, founder agreements in relation to share vesting, IP and non-disclosures, likely dilution in future rounds, etc.)
(Hustle Fuel represents my own personal views. I am speaking for myself and not on behalf of my employer, Microsoft Corporation.)