Part 1 of a 4 part series on how to angel invest. In this first post, we explore Strategy, "How will I invest?" The next 3 parts of this series will explore Sourcing: "How will I find deals?", Evaluating: "How will I diligence deals?", and Picking: "Which deals will I invest in?".
We often hear the question “how do I get started in angel investing?”. This post is intended to show you how a small handful of successful investors have approached the angel investing game.
I've pulled together and summarized key lessons from some successful angel investors including Paul Graham (Founder at Y-Combinator), Naval Ravikant (Founder at AngelList), and Tim Ferriss (From 4 hour work week fame).
As I see it, there are four functions to angel investing, we’re going to break these functions into four “chapters”:
Strategy: How will I invest?
Sourcing: How will I find deals?
Evaluating: How will I diligence deals?
Picking: Which deals will I invest in?
First, we’ll explore strategy.
How to Angel Invest Part 1 of 4: Strategy → How will I invest?
The first thing you learn at a VC fund, or as an angel, is that by investing in startups, you’re choosing to invest in one of the riskiest asset classes on earth. With this risk comes a unique set of rules, strategies, and consequences.
In order to play this game you have to be prepared to lose every dollar you invest 🔥🔥🔥.
As Naval Ravikant likes to say, consider yourself
“a patron of innovation”
Beyond the money, you’ll meet some very interesting people, sit at the front seat of innovation, and learn a lot from some very ambitious people.
Some of the smartest, most energized, and ambitious people i've met are via my VC & startup networks.
Step 1: Build a portfolio of bets
If you’re serious about angel investing, you need to build a portfolio of bets.
The reason? Because of The Power Law.
Put simply, The Power Law means that the majority of your returns are driven by a small fraction of your portfolio. The hope is that 1 or 2 of the companies you invest in will return more than the losses sustained on the rest of the portfolio. Startup investing is a game of home runs, not singles and doubles.
Here’s a good rule of thumb (checkout this sophisticated math):
1/3rd of your portfolio will go to 0 (💰 = 🔥)
1/3rd of your portfolio will break even (💰 = 💰)
1/3rd of your portfolio will grow (💰 = 🦄).
The hope is that one of these companies reaches breakthrough velocity and makes up for all of the losses you’ve incurred.
A good sized portfolio is 6 - 12 companies.
The fewer investments you make, the more concentrated your portfolio, which means higher upside if you pick correctly. The challenge is that picking correctly is incredibly difficult. A more appropriate strategy might be a less concentrated portfolio to have more shots on goal.
Step 2: Determine how much you want to invest.
Angel checks can range from $1,000 to $150,000. The most important thing is to stay true to a plan that works for you and your personal financial situation.
Nassim Taleb, the author of “Fooled by Randomness” and “The Black Swan,” advocates having a 10% ultra-risky portfolio, in other words, looking for a positive “black swan” - an opportunity for outsized returns. And the other 90% being balanced with ultra-safe investments. Many notable angels support this allocation.
For round numbers, let’s say you have $200,000 in liquid assets today. Based on this 10% rule, you can invest up to $20,000 into startups. A good rule of thumb is to spread this out over a few years to catch different “vintages” of startups -- yes, yes, this is a thing 🍷.
$20,000 over 2 years is $10,000 per year. Distribute this across 5 companies a year and you can safely invest ~$2,000 per company.
Here’s another example for someone with $1,000,000 in liquid assets. Your check size then would be $10,000 per company over 2 years, in a total of 10 companies (or $100,000 give or take).
The rough formula here is:
Step 3: Come up with investment principles
We won’t go too deep forming principles for now. We’ll focus heavily on this in our “how to evaluate a deal” newsletter in a few weeks. The important part is that you are aware of the process.
So what are investment principles? Think of them as guidelines you use to determine whether or not to invest in a company. When utilized correctly, they can be very powerful.
Tim Ferris covers this well. As a quick intro, Tim Ferriss is the author of 4 Hour Workweek and the host of the Tim Ferriss Podcast.
Tim was debating getting an MBA, but instead decided to invest into his “real world MBA”, where he would use the money he’d set aside for tuition to invest directly in startups. You can check out his story here & here.
In his words,
“I would aim to intelligently spend $120,000 over two years on angel investing in $10-20,000 chunks, so 6-12 companies in total. The goal of this “business school” would be to learn as much as possible about start-up finance, deal structuring, rapid product design, initiating acquisition conversations, etc. as possible.
The curriculum could be thought of as
“The Start-up Lifecycle from Birth to Acquisition/IPO or Death.” But curriculum was just part of business school; the other part was getting to know the “students,” preferably the most astute movers and shakers in the start-up investing world. Business school = curriculum + network.”
On his first investment, Tim broke a rule and learned a valuable lesson.
Tim invested $50,000 (far above the $10,000 - $20,000 per company he’d planned) into the first company he was excited by. A few years later, that company didn’t exist and his $50,000 burned along with it.
The lesson: As Tim would say
“Stick to your “Fu*king rules!”
Investment principles will steady your conviction in times of doubt. Some of the best investments are contrarian bets - the fact that it’s contrarian means that many people won’t agree with your investment strategy.
Mike Maples, a mentor to Tim and a well known VC at Floodgate says “Breaking your rules to co-invest with well-known investors is usually a bad idea, but following your rules when others reject a start-up can work out extremely well.”
Here are some examples of investment principles (This is not exhaustive. We explore this further later in the series):
Have a set amount of money you’re willing to invest per deal (e.g $10k per deal)
Only invest below a pre-determined valuation (e.g $10M valuation)
The company must have at least 6 months of steady revenue growth (e.g 15% growth month over month).
The company is highly scalable (e.g Not a paddleboard rental company).
The company must have 2 founders for when times get hard. If there’s only 1 founder, it should be a technical founder (e.g Engineer not sales).
There must be one successful angel investor already involved with the company.
Tims portfolio was immensely successful.
The 15 companies he invested in included Twitter (Market Cap: $55B), Uber (Market Cap: $89B), Shopify (Market Cap: $198B). It's probably safe to say that Tims angel investments have generated more wealth for him than anything else he’s pursued. Potentially hundreds of millions of dollars.
Tim had experienced guidance that gave him unique access to good companies. While you may not be best friends with a top-VC partner, you do have access to some top-tier investors via syndicates and rolling funds. We will cover that in-depth next week in our sourcing deep dive.Now that you understand the importance of strategy, take some time to model it out. How much should you be investing? What might be some of your investment principles?
THIS WEBSITE IS OPERATED BY EARLYPUBLICOFFERING.COM, WHICH IS NOT A REGISTERED BROKER-DEALER.
EARLYPUBLICOFFERING.COM AND ITS AFFILIATES MAKE THE INFORMATION AND CONTENT ON THIS WEBSITE AVAILABLE AS A SERVICE TO ITS CUSTOMERS AND OTHER VISITORS, TO BE USED FOR INFORMATIONAL PURPOSES ONLY. THE FINANCIAL INFORMATION CONTAINED ON THIS WEBSITE IS DERIVED SOLELY FROM THE APPLICABLE LISTED COMPANY, AND EARLYPUBLICOFFERING.COM DOES NOT VERIFY OR ASSURE THE ADEQUACY, ACCURACY OR COMPLETENESS OF ANY INFORMATION. NEITHER EARLYPUBLICOFFERING.COM NOR ANY OF ITS OFFICERS, DIRECTORS, AGENTS AND EMPLOYEES MAKES ANY WARRANTY, EXPRESS OR IMPLIED, OF ANY KIND WHATSOEVER RELATED TO THE ADEQUACY, ACCURACY, OR COMPLETENESS OF ANY INFORMATION ON THIS SITE OR THE USE OF INFORMATION ON THIS WEBSITE, AND ANY REPRESENTATION OR IMPLICATION TO THE CONTRARY IS EXPRESSLY DISCLAIMED, NOR SHALL ANY SUCH PARTY HAVE ANY LIABILITY WHATSOEVER ARISING FROM ANY ERROR OR INCOMPLETENESS OF FACT OR OPINION IN, OR LACK OF CARE IN THE PREPARATION OF, ANY OF THE MATERIALS POSTED ON THIS WEBSITE.
NOTHING CONTAINED ON THIS WEBSITE SHALL BE CONSTRUED AS LEGAL OR TAX ADVICE, AND EACH PROSPECTIVE INVESTOR SHOULD CONSULT WITH THEIR FINANCIAL ADVISORS, ACCOUNTANTS, ATTORNEYS AND OTHER PROFESSIONAL ADVISERS AS TO LEGAL, TAX, ACCOUNTING AND RELATED CONSEQUENCES OF AN INVESTMENT IN THE FUND AND AS TO THE SUITABILITY OF AN INVESTMENT IN THE FUND IN LIGHT OF SUCH PROSPECTIVE INVESTOR’S INDIVIDUAL CIRCUMSTANCES. ALL INVESTORS SHOULD MAKE THEIR OWN DETERMINATION OF WHETHER OR NOT TO MAKE ANY INVESTMENT BASED ON THEIR OWN INDEPENDENT EVALUATION AND ANALYSIS. ALL SECURITIES INVOLVE RISK AND MAY RESULT IN SIGNIFICANT LOSSES, INCLUDING THE POSSIBLE LOSS OF YOUR ENTIRE INVESTMENT. IN MAKING AN INVESTMENT DECISION, INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF THE PERSON OR ENTITY CREATING THE INTERESTS AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS AND RISKS INVOLVED. NOTHING ON THIS WEBSITE SHALL CONSTITUTE AN OFFER OR SOLICITATION TO SELL OR A SOLICITATION OF AN OFFER TO BUY, NOR WILL THERE BE ANY OFFER, SOLICITATION, OR SALE OF THE INTEREST IN ANY JURISDICTION IN WHICH SUCH OFFER, SOLICITATION, OR SALE IS NOT AUTHORIZED OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE ANY SUCH OFFER, SOLICITATION, OR SALE. THIS WEBSITE IS NOT, AND UNDER NO CIRCUMSTANCES IS IT TO BE CONSTRUED AS, A PROSPECTUS OR ADVERTISEMENT, AND THE OFFERING CONTEMPLATED IN THIS IS NOT, AND UNDER NO CIRCUMSTANCES IS IT TO BE CONSTRUED AS, A SECURITIES OR PUBLIC OFFERING.
THE FINANCIAL PROJECTIONS AND ANY OTHER ESTIMATED, PROJECTED, TARGETED OR ASSUMED INFORMATION ON THIS WEBSITE CONSTITUTE “FORWARD-LOOKING STATEMENTS”. PROSPECTIVE INVESTORS SHOULD NOT PLACE UNDUE RELIANCE ON FORWARD-LOOKING STATEMENTS, AS THEY ARE SPECULATIVE IN NATURE AND MAY PROVE INCORRECT. THE INCLUSION OF FORWARD-LOOKING STATEMENTS HEREIN SHOULD NOT BE REGARDED AS A REPRESENTATION, WARRANTY OR GUARANTEE OF ANY KIND BY EARLYPUBLICOFFERING.COM, ITS DIRECTORS, OFFICERS, EMPLOYEES, REPRESENTATIVES, AFFILIATES, AGENTS OR ANY OTHER PERSON OF THE RESULTS THAT WILL ACTUALLY BE ACHIEVED BY THE APPLICABLE COMPANIES. ADDITIONALLY, EARLYPUBLICOFFERING.COM HAS NO OBLIGATION TO UPDATE OR OTHERWISE REVISE ANY FORWARD-LOOKING STATEMENTS, INCLUDING ANY REVISION TO REFLECT CHANGES IN ANY CIRCUMSTANCES ARISING AFTER THE DATE HEREOF RELATING TO ANY ASSUMPTIONS OR OTHERWISE. EQUITY CROWDFUNDING INVESTMENTS IN PRIVATE PLACEMENTS, AND START-UP INVESTMENTS IN PARTICULAR, ARE SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK AND THOSE INVESTORS WHO CANNOT AFFORD TO LOSE THEIR ENTIRE INVESTMENT SHOULD NOT INVEST IN START-UPS. COMPANIES SEEKING STARTUP INVESTMENTS THROUGH EQUITY CROWDFUNDING TEND TO BE IN EARLIER STAGES OF DEVELOPMENT AND THEIR BUSINESS MODEL, PRODUCTS AND SERVICES MAY NOT YET BE FULLY DEVELOPED, OPERATIONAL OR TESTED IN THE PUBLIC MARKETPLACE. THERE IS NO GUARANTEE THAT THE STATED VALUATION AND OTHER TERMS ARE ACCURATE OR IN AGREEMENT WITH THE MARKET OR INDUSTRY VALUATIONS. EARLYPUBLICOFFERING.COM IS NOT ACTING IN A FIDUCIARY CAPACITY WITH RESPECT TO ANY USER OF THE EARLYPUBLICOFFERING.COM SERVICES, AND EARLYPUBLICOFFERING.COM DISCLAIMS ANY BROKER-CLIENT OR ADVISOR-CLIENT RELATIONSHIP WITH RESPECT TO ANY PARTY USING THOSE SERVICES.