Startup Investing Part 1: When and How

Introduction:

Angel investing is the process of providing capital to startups in the earliest few stages of their life cycle. It is categorised as very high risk, even for private markets, and is usually categorised as alternative investing. The glamorous self-imposed title of “angel investor” is bandied around by egocentric investors without any set criterion, which only serves to further obfuscate this asset class. It is attractive to investors because of the high growth potential — it is not unusual for successful angel investors to see 100x or even 1000x returns on capital. However, with that comes a high level of risk: thousands of companies pitch for investment each year, and choosing these pre-revenue and pre-traction is an almost impossible task. For this reason, it is prudent to make a number of investments in the hope that at least one pays off. Growth startup investing follows the power law: investment performance is not normally distributed but instead a very small percentage of investments make up almost all of the success of the whole asset class. In an effort to capture some of this success, it makes sense to spread your bets.

‍

‍

‍

Successful Angel Investments

So who angel invests? — what are some of the most successful angel investments? Some of the most successful angel investments of all time include Jason Calacanis in Uber and Jeff Bezos in Google, both of which returned 1000x + on capital. Perhaps it’s this kind of survivorship bias that cements the stereotype that angel investors have to be incredibly wealthy and often this is the case; it has historically been the pastime of ex-founders and successful businesspeople, but this is changing. As part of the global democratisation of finance and the reduction in barriers to entry of private markets, it’s becoming increasingly possible to write smaller cheques, gain access to larger networks and provide value to startups even as a small fish.

Benefits of Angel Investing

What are the benefits of angel investing? Aside from the power law of returns mentioned above, startup investments represent an alternative asset class not correlated with the market. In addition, there is significant tax relief available (up to 30% rebate on your investment amount in the UK for example), and the potential to stimulate growth in the next generation of companies you’re passionate about. The benefits of angel investing over VC are not talked about often — given that you are investing with proprietary funds, 100% of the gains are yours rather than the 20% that is industry standard in private markets (known as carry). Of course, this comes with its own set of challenges: a higher level of risk and more onus on your personal network being the primary two.

Wealth Requirements for Angel Investing

How wealthy do I need to be to angel invest? Ans: not massively wealthy but if you are not wealthy enough to make a lot of investments you need to be very confident as to the quality of your deal flow. How can you do this? Networking, joining angel syndicates, reaching out directly to companies you are passionate about using etc. Historically a large proportion of the best early stage companies in the world tend to come from the same few circles, so having access to these eg Stanford/Harvard/Oxbridge alumni is often a differentiator.

How to Be a Good Angel Investor

How can I be a good Angel Investor? Of course, finding good deal flow is the number one priority. But beyond that, the ecosystem is small and if you deal with honesty and integrity, that will pay dividends in the future. You’ll build up a reputation for yourself and the results will naturally compound. Think about what value you can add that might set you apart from traditional VCs and why a founder might be predisposed to squeezing out room in what is likely a competitive round to make way for your smaller ticket. Are you an operations expert? Marketing? An influencer? A designer? Founders send out investor updates regularly and it’s down to you to take the needs from those and add value where you can. This is something, despite the “Let me know how I can be helpful” cliche, is something that very few investors actually do. In fact, many actually detract value — Hall of Fame Silicon Valley angel investor and VC Vinod Khosla reckons 70–80% of VCs actually add negative value to portfolio companies.

Alternatives to Angel Investing

What are the alternatives to Angel Investing? There are other ways of becoming involved with the startup ecosystem. As we see it, there are two ends of the spectrum that might push you away from angel investing and towards an alternative. The first is that you have the spare cash to invest, but don’t have the network to leverage to be confident in making strong investments. The second is the opposite: you have plenty of great companies in mind, but no cash. What if I have neither cash nor investments, I hear you ask. Well, it would probably be best to spend time building up either before considering angel investing, and perhaps private markets more generally. So, the first — spare cash, no network. This cash could perhaps be allocated to VC funds that broadly fit your mandate. They would choose a pool of companies in the realm in which you’re interested, and you’d be able to own a slice of each without the stress of choosing. You’d be giving up a % as fees, but that’s par for the course. It’s also better to have 90% of something than 100% of much less (or nothing).

Scouting and Networking

What about the second: plenty of pipeline, but no cash. Well, you could become a scout for example — if you have the perseverance to access great companies but are just lacking capital, investors will often give scouts a % of their carry for deal sourcing. This is also a good way to build relationships and network. Given the incredibly long feedback loop in angel investing (5–10 years to outcome is often the norm), it also makes sense to start as early as possible in order to figure out any pattern of success. Many great investors take decades to learn what precisely worked and what didn’t. There is also the possibility of joining Angel networks and investment clubs. Be cautious however — many of these claim to be much more active and successful than they are, and will no doubt charge you (and often the startups too) for the privilege of being part of their network. You have been warned!

Tracking Investments

Finally, how to keep track of any investments you do make? You’ll be pleased to know that Strabo is scheduled to release an angel investment tracking function that will allow you to follow investments, distributions and related tax relief for your jurisdiction. You can sign up or get in touch directly at hello@strabo.app.

Conclusion

Happy Hunting!