I wrote about Angel Investor Bill earlier. Bill follows a simple strategy, he invests in great companies run by great founders, and he only cashes out at the IPO. Bill pays a lot of taxes because he doesn’t know anything about the tax incentive.
The new tax incentive for angel investors and the Atlassian IPO millionaire effect will create a new wave of tech startup investors in 2016. Below are the strategies I wish someone had shared with me when I first started my angel investing journey.
This is a discussion around risk management and deal flow, not specific advice. Please consult your financial, tax and legal advisor before you make any investment decision.
The portfolio approach
I have seen investor bet big on one single startup. The startup would fail (like 90% of the time) and the investor would then claim that angel investing is total bullshit.🤦🏻♂️️
The portfolio approach minimises this risk. You can invest the same amount in 20 companies over a number of years. Evaluate if the company can return 20 times the investment. For example, you invest at a $4 million valuation, can this company get to $80 million valuation someday and how?
This way, you can be wrong 19 times and still get your money back. If you get two right, congratulations, you have made a 100% return on your whole fund.
The follow-on approach
Startups send monthly updates to their investors. While reading the updates, investors usually have two different reactions. Either “Damn, I wish I hadn’t have invested in this disaster”, or “Seriously, I should have put more money into this gem”.
To double-down on the good companies, you can invest the same amount in 15 companies over a number of years, and set aside some capital to invest in the next financing round (usually Series A) of the top 5 companies.
This way, you can concentrate on the winners and you will have more confidence in the team, after tracking their progress and execution for a while.
Group effort
Some investors are like great poker players: they can quickly categorise founders and they can call a bluff. Some investors can tell if the excel spreadsheets make sense or not. Some investors can look at the tech stack and know if the development team is doing a good job. Some investors know how to achieve a good balance on the investment terms: not too predatory while having enough down-side protection. Are you all of them?
Angel investor groups are great because you get to meet people with different domain expertise. I was a member of Sydney Angels and I have learned a lot by participating in the syndicate due diligence meetings over the years. There is probably one group in each Australian capital cities now.
This way, you get to see the different perspectives, hear about the different investment theses and then get to your own conclusion. This is also an economical way to go, unless you can afford to hire an expert team to do the investigation for you.
Become the go-to person
If you know an industry particularly well and are connected with all the prominent players in the sector, it makes sense for you to build up a profile as the go-to person of that sector.
People will forward you a deal and ask for your opinion. People will ping you for an introduction to a potential customer. People will ask you to help evaluate a product or a service.
This way, you get to observe what’s happening in the vertical and identify powerful disruption before the crowd.
The accelerator funnel
Do you have the time to read through 200 pitch decks every year, meet the founders for coffee, evaluate their businesses, call some experts for a second opinion and get to an investment decision? That is about 1 startup a day if you don’t plan to work during Christmas.
Accelerator programs are great because a group of experienced mentors filter through 200 applicants each year, the mentors interview 20 of the most promising companies, and eventually take 5-10 through a 3-6 months program and give them access to the mentors’ international business network. You can pick a company from the batch of 10 at the demo day and follow up.
There are more than 10 accelerators in Australia now. A simple way to assess the quality of an accelerator is by looking at the number of companies that have successfully raised money after the program. You can also ask founders that have been through the program for a reference. I work with Startmate in Sydney. Subscribe to their newsletter and they will let you know when is the next demo day.
This way, you only have to look at the vetted top 5% companies that have the support and network to progress further, the cream of the crop.
I am not saying that companies can only be successful after they have been through an accelerator program though. Some great companies actually don’t, they bootstrap to profitability on their own, investors have to find them and convince the founders to take their money in this case. True story!
Referral from the founders
Startup founders work closely with other startup founders. They are constantly evaluating tools that could help propel their businesses. As a result, founders are more likely to come across a really good product before an investor does. This is especially true for the business software and developer tool category.
If you are likable and can add value, founders will refer good teams and products your way. This way, you will be able to keep your finger on the pulse of the market and the ecosystem better than anyone else.
Follow the super angels
Super angels are usually entrepreneurs that have successfully built, scaled and exited their previous businesses. Armed with a lot of time, cash and experience, they now want to actively invest and help the next wave of Australian entrepreneurs.
Super angels are the most valuable kind of investors because they have deep empathy for the founder’s journey. They know how to solve a problem because they have done it before, and they have relevant business contacts that can help.
If you are fortunate enough to get a chance to work with the super angels, you will learn the true meaning of the “angel” component in angel investing.
Leave it to the professional
Proximity is very important for angel investors, if you are not close enough to the best deal flows, the startup you get to meet will likely be the “left overs”. The best investors attract the best companies because they help the companies to sign up anchor customers and partners, hire super star employees and close later stage investors. If the best investors pass on the opportunity, the companies will talk to the next best investors. Simple as that. I have definitely fought hard to be included in some amazing deals over the years.
Venture fund managers are the professional investors with the big cheque-book and brand presence. The best startups usually talk to them first. One can invest directly into a venture fund, or cherry-pick and co-invest in some of the deals with them.
There are 17 registered ESVCLP funds in Australia now. A simple way to assess the quality of a venture fund is to look at their IRR, try to aim for at least 20% net IRR. You can also ask founders of their portfolio companies for a reference. I invested in Blackbird Ventures and I am always very happy when they send me my NAV statements and portfolio updates.
This way, you can piggyback off the fund managers’ hard work and still learn a lot by reading the investment updates. They are also more likely to find the successful “bootstrappers” (mentioned above) before you do, because this is their full time job.
Join us
Angel investors typically invest between $10,000 to $100,000 per deal. Startups usually want to raise between $300,000 to $1 million for their seed round. As you can see, a syndicate of investors is usually required to fill the whole round.
It takes a fair bit of effort to setup the deal flow properly. I haven’t even covered evaluating a startup, closing a round and post investment management yet. So, it makes sense for us to join forces and leverage off each other’s skill set, unless you are as resourceful as Mary.
I have a group of investors that I like to co-invest with, we catch up regularly to share deal flow and bounce ideas off each other. We also gossip about stuff in the industry. I am happy to have a chat if you are interested in joining us.
If you have a good strategy that you would like to share, please leave a comment below. I am always keen to learn more so that I don’t lose all my money.
If you know someone who wants to start angel investing this year, share this article with them. If you know a Mary, please introduce her to me.
Read this too. https://marker.medium.com/dear-first-time-angel-investor-c6af249a694b
This is part 1 of the series:
