Insight from Chris Leondires
Angel investors are individuals that play the risky game of investing in startups and entrepreneurs. In the world of angel investing there is no guarantee that a company will return even a fraction of an investment. In order to receive a solid return on an angel investment portfolio, smart and sustainable decisions are key. Since these investments are at such an early stage, it’s important to understand that returns might not be seen for up to 7-10 years.
To be an angel investor you must be considered an accredited investor. The criteria for this title is possessing one million dollars or more of investable assets (excluding your primary residence). An angel investor is any individual who has an income of over $200,000 or a couple with a joint income of over $300,000 for at least the past two years. When investing these assets, angel investors typically contribute smaller amounts of funding than venture capital funds. Their average check sizes are between $10,000 and $50,000. One of the biggest mistakes investors make is putting too much money into too few companies. It is recommended that an angel investor not dedicate more than 5-10% of their investable assets to angel investing. About 90% of startups fail, which is why a portfolio should be well-diversified and include many companies. An investor should never jeopardize their life savings when making angel investments.
When investing in high-risk, early-stage companies, there is no need to rush into an investment. It is often effective for investors to contribute capital to industries they know well and in which they have connections. By developing an area of expertise, investors are familiar with the market and some of the prominent players within it. This is useful because the best way to hear about new deals is through word-of-mouth.
Sometimes an idea may be so complex and different that an angel could turn away from a deal based on uncertainty. Angel investors often reference their extensive investor network to look at an industry with which they’re not familiar. The Rines Fund provides a substantial value-add to angels and angel groups by providing comprehensive due diligence that leads to better informed investment decisions. Not only is it smart for investors to invest in industries that they know, but it is also effective for them to invest in companies that are close to their residence. That way, they can remain active in the business, monitor it, and potentially harness their investor network to bring in more capital. An angel investor is not necessarily someone who is just writing a check. They often contribute to the progression of the company, get frequent updates, and offer guidance and advice. One of our guest speakers, John Kealey, a managing partner at an early stage investment firm, said “As someone who is investing either by yourself or with a partner, you need to be extremely sure of your decision. Often times you are dedicating 5-7 years of your life to help build the company.” It is not uncommon for investors to offer their experience and expertise as a resource for the company.
It is often better to invest the same dollar amount into each company in a portfolio. If a $25,000 investment in company A fails to yield a return and a $10,000 investment in company B yields a return of 2x, there is still have a net loss of $5,000. If both investments were for $10,000 and yielded the previous result, there would be a net gain of $10,000. Investing a similar amount in each company pursued is a good way to mitigate the risk of losing an excessive amount of money on failures and returning a minuscule percentage on a winner. It’s important for investors to maintain a consistent strategy when analyzing companies, conducting research, and finalizing an investment. By diversifying and investing a consistent amount, the few investments that do make a return will offset and hopefully exceed the losses endured from the companies that fail.
Another frequently used investment strategy is syndicating deals with other investors. This is especially useful if someone is just getting involved with angel investing. Whether investing in earlier seed stages or later rounds, pairing up with reputable angels can provide a sense of comfort. An experienced angel often has been a part of many successful exits, which primarily refers to an acquisition. Being a part of a successful exit is a notch in the belt for angels. Within our unique angel fund, we often do extensive research on potential exit opportunities. A term sometimes used within our group to describe a company is “walking dead”—in other words, a company that may generate revenue and have a positive net income, but that doesn’t fill a need in the marketplace and therefore won’t likely be acquired. Angel investors and the Rines Fund often shy away from “walking dead” companies, as it’s suspected that they won’t provide an adequate return.
Another strategy angels will take is establishing provisions that prevent the owners of the company from selling their shares. This will prevent the CEO and other members from bailing on the company if earnings start to tumble or if there are struggles reaching commercialization. A consistent takeaway from nearly all of our guest speakers has been that many of their investments are backed by their faith in the management. As our very own advisor, Professor Jeff Sohl, has said, “You are investing more in the jockey than the horse.” He often stresses the importance of analyzing the leadership team, as they have to able to overcome the many challenges they will inevitably face. An entrepreneur lacking confidence and experience may not have what it takes to turn a good business model into a profitable company. It’s important that an investor believes in the CEO and others leaders of the company because they will ultimately be what propels the business to success.
When a company pitches, investors should question everything about which they’re uncertain. It is important never to leave a stone unturned; there should be no sense of doubt when finalizing the deal. Investors should not become emotionally attached to an investment nor contribute more capital than usual. As mentioned earlier, this jeopardizes the overall return of a portfolio and often leads to empty pockets. Investors should not be afraid to turn down a deal and to identify companies that do not have a realistic exit strategy. If investors don’t see themselves making money in the end, it may not be worth it. Getting to know a company’s employees, behavior, and environment before investing is critical, too; it’s crucial to understand that the investment is in ideas and people. Staying committed to these strategies will help minimize the risk when investing as an angel. Before a person starts heavily investing in startups, it’s important to note that angel investing is supposed to be enjoyable and is often a way for retired executives and businessmen to stay active. An investment strategy is always tailored to the individual, but with some of the basics highlighted in this article an investor can potentially make more educated decisions.
Chris Leondires studies Accounting and Finance. He hopes to work at a public accounting firm upon graduation and eventually get involved with investment property.