Think you have what it takes to be an angel investor?
By Mor Assia (Founding Partner, iAngels)
Everyone knows 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.
Read below to see whether angel investing is a good fit for your personality, or whether you should stick to other asset classes.
Are You Willing to Take the Risk?
It seems as though every day we read about another startup exit. TechCrunch and Venturebeat are flooded with the success stories that stir up jealousy in all of us. The 20-something-year-old entrepreneur who just raised seed funding and already sold his company for hundreds of millions. And let’s not forget the angel investor who recognized the potential and made the investment of his life.
It’s easy to get excited by these stories, but the harsh reality is much different. According to the National Venture Capital Association, 25 to 30 percent 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 percent of all VC-backed firms in the U.S. don’t return investor capital. It’s 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 low, it’s recommended to only risk a percentage of your portfolio that you wouldn’t mind losing — usually 1-5 percent 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’s 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 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.
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 1990’s. 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.
This post originally appeared on the iAngels blog.