Marianne Hudson, executive director of the Angel Capital Association (the trade association for angel investors in the US) wrote an article making the case for wealthy to consider becoming angel investors. Her full article (with her permission) appears below:
With angel investing being so risky, eventually most smart angels wonder – is there a way to increase my odds for good returns? And how else do I make investing a good experience for me?
Here’s the good news. Studies show that angel investors can make good returns, on par or better than VC or other types of private equity, when they follow some good investment practices. The studies put proof behind what was previously just common sense. On top of that, many angels are having a blast investing in startup companies and are happy to share their secrets for fun.
Let’s start with the largest study and what we can learn from it to enhance financial returns. Rob Wiltbank, CEO of software company Galois and professor at Willamette University, collected data on exits – good and bad – from hundreds of angels in the Returns to Angel Investors in Groups. The study found that the overall return for the 1,100 plus exits in the dataset was 2.6 times the invested money in 3.5 years, or about 27% gross Internal Rate of Return.
More important than the average return for this “portfolio” of 1,100 exits, was the very wide and unbalanced distribution of the exits, with 52% of the exits losing some or all of the investment and 7% providing nearly all of the return. This means the average in the study didn’t describe the performance for most of the angels who participated. But there are some good takeaways that can lead to better returns:
- Look for the home run opportunities. As Wiltbank says, “The returns are massively skewed. Ten percent of all of deals produce 90% of the returns.” Really sophisticated angels have paid attention to this. A few top angels have told me they started out looking for singles and doubles, thinking they could make most of their returns in those deals. Now they have changed their game – it’s all about hitting home runs.
- Diversify your investments. Not only does a small percentage of deals deliver the biggest returns, but there a 50-50 chance that each individual investment will be a failure or a success, so you need to make many investments to find the one that will be a home run.
- Take your time and be patient but persistent. The 52% of the exits that lost money did so in an average of three years, while the big returns took an average of six years. As you wait for the bigger returns, learn from your experience by watching others and enjoy the process and the angels and entrepreneurs you meet. (More on this later.)
- Do due diligence. Just looking at amount of time in due diligence, angels who did more than the median amount of diligence on a deal (20 hours) did significantly better than those below the median. The overall multiple difference was almost six times – 5.9X compare to 1.1X! This is mostly about reducing failures. Said another way, 65% of the below-median due diligence angels lost money, compared to 45% for the above-median group. Now, there’s a reason to roll up your sleeves to check the companies out!
- Invest in what you know. Putting your specific industry expertise into your investing is common sense. The study showed that when the investor had expertise in the company’s industry, the exit was three time higher than for others (3.7X compared to 1.3X, both in around four years). Use your entrepreneurial experience too. Wiltbank says that “angel investors are well suited to early-stage investing because many have been entrepreneurs themselves.”
- Stay connected to the entrepreneur after you invest. Investors who met with company leaders often to mentor, coach, or offer strategic consulting and that monitored the company’s progress saw an overall multiple of 3.7X in four years. Conversely, those who took a more passive approach reported an average lower multiple of 1.3X in 3.6 years.
Angel investing is about financial returns, but it is so much more than that. As top angel David S. Rose wrote in his recent book, “…investing in startups has so many other dimensions that, for quite a few angels, the external rewards may be even more important than then financial ones.” He sees a number of non-cash benefits that come with your “angel wings,” from “entrepreneurship without responsibility” to giving back and developing life-long friendships.
My organization, the Angel Capital Association, gives an annual award to one person who makes a big difference to angel investing and one of my fondest memories is watching the first winner receive his award in 2005. Bob Goff, leader of the Sierra Angels in Nevada, won not only for his active investing and support for the entrepreneurial community, but for his total embodiment of angel investing as “doing good, having fun, and making money – not necessarily in that order”.
That phrase has stuck with me and so many other angels I know. Many angels enjoy spending time with other smart investors, meeting remarkable entrepreneurs and learning about interesting and innovative ideas. Beyond the personal experience, it’s wonderful to know as an angel that you’re helping build the economy, creating jobs and life-changing innovations, and giving promising new businesses a chance.
And I can’t leave Rose’s “entrepreneurship without responsibility” without another comment. One of my favorite angels has said how much he loved starting his very successful company and selling it for a great return, but not so much the part in the middle (running and growing the company). As angel investors, we know the responsibility for the company’s success is with the CEO and we can enjoy being involved with the company without taking the responsibility “in the middle” of getting to a great exit.
Angel investing offers many returns. What could be better than doing good and having fun while employing good investment practices that make money at the same time?