The Hacker's Guide to Angel Investing
‘I’m an angel investor’.
It can be a serious endeavor, a path to fortune or merely a hobby where you like being at the crux of building great ideas.
The type of angel you are is your own choice.
The focus of this post is to help new angels understand the social side effects and market dynamics, so they know better than most do about what they’re getting into.
Straight to the point - what are the benefits?
“Angel investing is a priceless way for entrepreneurs or executives to get to know the other side. In the age of being able to invest 5–10k, most tech leaders with money should do it at least once.”
The $5K Angel?
Yes, you can call yourself an angel investor with a single $5,000 investment! Instead of buying a foreclosed house or a Bengal cat, give yourself the ultimate gift! And if you want to max out on ‘angel investment theatre’ you could have a 10-companies portfolio for $50k. Wow.
How do you do that?
You join an Angel Network! (Like, yours truly, 1stCheque)
Can it make money?
Note that if you’re very lucky, even a tiny investment can turn into something significant if:
- Done very early (generally a valuation sub $5M. $1M-$2M is best)
- … With a startup that executes superbly
For example, to get $1M out of $5k (200x), it requires a startup to go from — dilution included — a $2M valuation to… $800M (2x200x2). Not so common in a world where a 10x return on a single deal is celebrated ^^
The reality — you’ve heard it before — is rather to:
‘Assume you’ll lose everything. Because you probably will lose some.’ But that shouldn't stop you, because one win could overpower your 10 losses.
The Real Reason Why You Need Over 10 Investments To Do Well (it’s not what you think)
This is what you often hear about angel investments.
The reason is NOT a general way to “gain experience", although that does help. Those are mere correlations to something more important: improving your deal flow and mitigating risk.
The first deals are the cost of getting access to better deals
It is NOT the cost of getting ‘smarter’ as in ‘better at picking deals’.
Again, the problem is NOT how good you are at finding the needle in the haystack, but rather:
- Are you looking in the right haystack
- How many needles there are
How the game is really played
The new companies started by the top dogs and serial entrepreneurs in Silicon Valley (and elsewhere) are generally filled with money from their inner circle.
Most angels won’t see those deals.
So as an angel you will start with deals everyone else has passed on, or from founders who have no network. They are the riskiest out there.
In fact, thinking you’re good at picking is probably the #1 risk.
Your effort is better spent seeking the better haystacks, making sure they’re full of needles, and tagging along with experienced needle-finders!
Then, as you start broadcasting your angel investor activity, maybe you will establish some deal flow and a bit of expertise in a domain or geography, and you will gradually see better deals.
If I was doing it all over again, I would recommend to my younger self to:
- Team up with experienced investors
Their deal flow will help you, they will sort out all the legal stuff, negotiate a price, etc.
- Keep your checks balanced across deals. Mine had some significant differences. Paradoxically, the tinier checks yielded the best returns (if startups have the same level of risk, keep in mind that $10k at $1M is the same share as $50k at $5M, but 10x on $1M is much easier than 10x on $5M).
The first checks have to be small.
It’s also easy for these checks to add up to a significant sum. Never put more than 10% of your net worth into this, no matter how good it makes you feel. And if you choose to do it, we recommend to spread it along 5 years: 1%, 1%, 2%, 3%, 3%. It’s very easy to invest 10% of your net worth into startups in 1 year. It’s a terrible mistake.
- Exit partially every couple of rounds rather than keep risk all the way to the end.
- Make sure the business model is straightforward, scalable and that unit economics work
Some companies can handle numerous pivots before sorting those out, but most die trying.
- Grit and resourcefulness > Branded degrees and experience
Beware of fancy offices and Silicon Valley costs. Frugality also improves odds of survival during tough times.
- Your best investments likely won’t need you
And those who do might make you wonder how you’ve come to pay them to even … work for them for free!
- You only need one
A truly successful investment can bring you wealth (though it’s hard). Buying a famous logo can get you a reputation (less hard).