Angel investing - For fun and profit(?)

My first angel investment was made April 6th, 2019 and at the time of writing this I have a total of 12 companies in my angel startup investing.

Does this make me qualified to speak on angel investments? I think so. But as always, do your own research, and don’t take the words from a random person on the internet as objective truth.

Also, keep in mind the beginning of my career as an angel investor included the last two years of one of the greatest bull markets in history and, it's no guarantee that what used to work for me in the past will work for you in the future.

With that out of the way, let's get into it!

Why make angel investments?

Early stage startup investments is one of the weirdest asset classes that exist.

In a nutshell it works something like this. You meet with a founder with a vision for how to build the future and are (sometimes) shown a prototype of a product for how to build said future. You then give them some money and if you are really, really lucky you get back some multiple of that money after waiting ten years. What’s more likely, though, is that another future unfolds and you lose your whole investment.

In other words it’s really important to be clear about why you invest.

For me it’s my passion about being a part of something great that makes an impact on the world. I get a lot of energy from meeting with all these amazing, really smart investors and founders hellbent on shaping the world to fit their view of reality. And by giving up a bit of my money and a bit of my time, I get to come along for the ride. And hopefully I will be able to make some money on it down the line.

Those two reasons, money and thrill, are the most common reasons that I’ve found. But there are not the only ones. Angel investing is also a common way into Venture Capital. Make 10+ investments, maybe lead an SPV¹ or two and you have a track record showing that you know how to source and win deals. This is more worth to a VC than any MBA.

Whatever the reason, make sure you are 100% clear about why you do it, or this world of high stakes will crush you before you know it.

Money out, money in

Now that we have nailed our reason for getting into the game, let’s get a bit more practical. Before even speaking to a founder, take a long hard look at how much money you can spare and how much to put into each company.

A common mistake that people make when getting into angel investing is that they put too much money into their first couple of deals and lose it all within the first year or two. I made this mistake too. I put too much money into my first couple of deals, and why it might turn out ok (ask me again in 3-5), I will consider it a good outcome of a bad decision.

Don’t let this be you. Start looking to diversify your angel portfolio from the start to make sure you invest in enough startups to give yourself a chance of finding at least one great investment.

Not good. Great!

This game is about finding winners. Sometimes you do of course have an investment that returns capital to you. But on the whole it doesn’t really matter. Why? Because of the power law. 90% of startups fail. In other words 9 out of the ten early stage startups that you invest in will likely return 0 or close to 0.

Let’s take a moment to look at how the math works out. Say you have one good investment that returns 10x your investment. Sounds pretty good, right? How about when you factor in the risk of returning zero. With ten investments where one returns 10x the investment and 9 goes to zero, you’re still only break even.

But what if half of them returns double the money? For the sake of simplicity, let’s assume that you invest $10000 in ten companies. One returns 10x, so that’s $100000 in the bank. Five double the money, so that’s another $100000. The four that are left go to zero. Wow! $200000! You’ve doubled your originial money. But over how many years?

Great businesses take a long time to build, so let’s say it takes 10 years to get your money back. That’s an annual rate of return of just over 7%. I’m simplifying a bit, of course. You won’t make all investments at the same time and some exits happen much faster than 10 years. But it should be clear that you need a really big win, 30x or higher, to consider yourself successful.

Time is money

You will also want to spread your investments over multiple years. This lets you hedge against makro events that change the investment climate (hello covid, Russia and crazy inflation) and allow you to catch technology waves that are one in a generation. In VC this is commonly referred to as vintages.

To illustrate the importance of vintages, imagine you made a plan to invest $1.000.000 in ten companies, and you decided that it was important to deploy all of that capital all at once in 2021. At the time of writing, the value of most of those investments will already have dropped by at least 50%. Or in VC speak, the 2020-2021 vintages will probably not be as great as originally thought.

Pacing your investment over multiple years gives you one more advantage. You get another reason to say no. And you want to say no a lot, especially in the beginning. Saying no a lot means you get to see a lot of deals and get a better feeling for what a good deal looks like. Use time to your advantage here.

Thesis

Your thesis is how you define yourself when meeting with founders and other investors. It describes what you invest in and why. As you talk about it and make investments in it, people will start to learn what your type of deal looks like. This helps the right type of deals find their way to you, but it also helps you make investment decisions.

You can skip this and just say you invest in anything, but I find that this is much more difficult, as you will be comparing vertical farming cases with network effect enabled social trading apps and rocket ships. These are very different industries and each require a very different lens through which to evaluate it.

So how do you construct your thesis? Mathew DiLallo has written an excellent guide over at Motley Fool, so I won’t go into details, but here are some quick tips if you want to keep it simple.

Start by selecting an area where you are going to make investments. For example:

• Pick an area where you have previous experience. For example, I’ve spent over a decade in consumer facing mobile apps, so that was my entry point.
• Pick an area which you are deeply passionate about, that you think has huge potential to grow. Climate related investments is one example that is still attracting a lot of new investors.
• Pick a technology trend that you think will dominate the world in the next 20 years. E.g. AI.

Once you've selected an area, make sure to define why it’s important to you. This will help you with conviction later on.

Lastly, decide on where you want to invest. Are you investing globally or are you strictly investing in companies in your city?

Once you have all three, you have your basic thesis and you’re good to go.

Stage right

There are many opinions on at which stage to invest in a startup. In general, the earlier you invest the greater the upside, so you might think that you want to get in as early as possible. But the earlier you invest the greater the risk.

For me it all comes back to dilution and how large a portion of the company I can get for my money. Since I’ve already accepted that I will be diluted like crazy, I should aim for a larger stake, which in turn means early stage investments. Usually pre-seed or seed.

These are also easier for me as a small angel to get into. Later stage rounds (B and upwards) are usually so large that an additional $10k from an angel means more administative work (e.g. chasing people to sign legal documents) than it’s worth, so they tend to be filled by VCs and previous investors investing their pro-rata.

A consequence of this strategy is that you will be tiny on the captable and you will get to experience heavy dilution along the way. This is totally fine. You can offset it a bit by follow-on investments, but when you come into the territory of $300m rounds it’s no longer meaningful.

VCs will typically be very afraid of dilution, but they tend to run a more concentrated portfolio of bets and own much larger stakes in the companies they invest in. You are not them.²

When starting out as an angel investor you probably won’t need to think too much about this, as it will largely be dictated by your deal flow which, most likely, will be filled with early stage deals.

Dealflow

Dealflow is a fancy word for the rate of potential investments that come your way and how good those deals are. You will lose 100% of the deals you don’t see. Thus your returns will 100% depend on the quality of your dealflow. This goes hand in hand with wanting to find great, not good, deals to invest in.

This is part of the reason why early stage investing is a team sport. You will need to work with other investors to share deal flow and improve your dealflow quality together. This is why I recommend most people starting out to join a syndicate or find an angel network somewhere. There are a ton of them these days, but just to name a few.

• Hustle Fund’s Angel Squad - Angel community run by Hustle Fund.
• Vitalize Angels - Angel community run by Vitalize VC.
• Fund Fellow Founders - Angel investor community based in Estonia, investing all over the Nordics.
• Nordic Angels - Invite only community for angel investors in the nordics
• Nordic Angels - Invite only community for angel investors in the nordics

The upside of joining a syndicate, apart from dealflow, is that you get to learn from some really smart people who have been doing this for a long time. I was part of Vitalize Angels for a while, and getting an opportunity to learn from people such as Gale Wilkinson has no doubt made me a better angel investor.

The second thing I recommend people do is to tell the world that you are angel investing. Just putting angel investor in your LinkedIn title will make sure you start getting inbound dealflow. The quality of this deal flow will vary a lot, though, so expect to discard at least 95% of it without a meeting. That said, I have made investments in startups where the founder made a cold outreach on LinkedIn, so there is some value to it.

Finally, it’s very important that you understand that most of your future dealflow will come from other investors. What I like to do to improve my network and deal flow is to reach out to 10 investors on the cap table of the startups I invest in. Since you’re both on the captable it’s not a completely cold outreach. I still haven’t had anyone say no to a remote coffee send a Cal.com link with your first email) or a lunch meeting.

As you grow your network you will be invited to more and more syndicates and networks, and this is where you can start being picky with which networks you invest more time into. At the beginning though, it’s more important to get some skin in the game so don’t overthink it. Just pick something that suits your wallet and level of commitment.

As a side note, I also created my own slack group with people that I felt I trusted and wanted to work with long term. This has served me well, but it takes a lot of energy to maintain your own community. As I started to direct my attention elsewhere the activity in this group dropped to close to zero.

Wrap-up

Angel investing is one of the most interesting asset classes available today. It’s also the type of investing that I enjoy the most, partly because I’ve gotten to meet with so many amazing people (both founders and investors) over the years. But also because the stakes are so high. I look for moonshots, so it’s more or less go big or go home.

One important point that I haven’t touched on yet though is how much of your net worth you should be investing. This is because it depends a lot on your personal risk tolerance (hint, it’s probably lower than you think it is). The general recommendation I see is somewhere around 5-10%, and that is probably good for most people.

Just keep in mind that you should never invest money that you cannot afford to lose. Losing it all is a very real risk when investing in early stage startups.

When it comes to check size a common number is $25k. You can go higher if you have the bankroll to back it up, but I wouldn’t recommend going lower if you are going to do a direct investment. If you can’t do $25k I recommend checking out AnglelList’s RUVs or angel communities such as Vitalize, where you can sometimes get into deals for as little as $1000 per investment. Note though that I consider this to be more closely related to crowdfunding than traditional angel investing.

You could also go out and find angels who invest in similar areas and do SPVs (joint investments) with them, so that you collectively reach a check size that founders will accept.

Finally, thank you for investing your time and for making it all the way.

As always, if you want to know more, if you disagree with me on any of the points above feel free to react out to me on viktor [at] [nyblom.io] or via my Twitter.