Secrets of Angel Investing from the Top Angel Investors

Angel investing is a game with asymmetric upside - worst case, you lose 1x your money; best case you 1000x it. If you apply good judgment, and play the game long enough, you’ll win. Because of these odds, you should start early, swing often, and learn as much as you possibly can about making good investment decisions. The challenge here is that startups are complex and making “good” decisions isn’t easy. This is where investment frameworks and rules of thumb can become extremely powerful. In this post, we’re going to explore 33 lessons from some of the top angel investors in the world. These investors use these principles to guide their thinking around startup investing.

33 Lessons from top angel investors

Angel investing is a game with asymmetric upside - worst case, you lose 1x your money; best case you 1000x it.

If you apply good judgment, and play the game long enough, you’ll win. 

Because of these odds, you should start early, swing often, and learn as much as you possibly can about making good investment decisions.

The challenge here is that startups are complex and making “good” decisions isn’t easy. This is where investment frameworks and rules of thumb can become extremely powerful. 

Today we’re going to explore 33 lessons from some of the top angel investors in the world. These investors use these principles to guide their thinking around startup investing. 

Let’s dig in!

Naval Ravikant and Babak Nivi, Co-Founders of AngelList

AngelList


Naval and Nivi are some of the most well known investors of our generation, with investments in companies such as Twitter (Market Cap: $37B), Yammer (Acquired for $1.2B), Uber (Market Cap: $78B), OpenDoor (Market Cap: $10B). Here are their 11 rules on angel investing. 

1. If you can’t decide, the answer is no

If you can’t decide on an investment, the answer is no. For all practical purposes, there are an infinite number of investments out there, so pass. 

That doesn’t mean you won’t regret it. But the next investment is just as good a priori.

Your experience and judgement is only going to get better by the time you see the next deal.

2. Proprietary deal flow means ‘they want you’

Nobody thinks they have a shortage of dealflow. The hard problem is getting your money into the startups you want. The company has to want you over other investors.

Without ‘they want you,’ you will get cut out of good investments and end up with adverse selection of weaker companies. It’s okay to pass on investments, but you don’t want them to pass on you.

Missing out on a few investments can mean losing all your money because of the power law returns of investing: the top deal in a good portfolio returns as much as deals 2 through N combined. If you miss out on the top deal, you’re going to miss out on most of your returns.

You never want to hear, “I will come to you if I don’t get money from Sequoia.”

3. Investing takes years to learn, but improves for a lifetime

Get started with angel investing now. It takes years to learn and longer to see returns.

You want to invest in 30 companies at a minimum–that takes time. Start with small investments because your later ones will get better as you gain expertise and brand. So your returns will take even longer.

Investing takes a long time to learn, but it is one of the few professions that you can improve until the day you die.

4. Valuation matters: you will have to pass on future greats

You can’t build a portfolio of pre-traction companies at $8-10M pre-money and expect to make a venture return. On occasion, you can make an exception, but you can’t do all of your investments at this price.

You will have to pass on great teams because the valuation is too high. You will have to pass on future iconic technology companies because the price is too high. But passing at a $40M pre-money lets you take 10 shots on goal with unknown companies at $4M pre-money.

You can’t negotiate valuation unless you’re investing 1/3 to 1/2 of the round. Or if you’re the first check in the company. Start the negotiation by saying, “I like you but I can’t make the valuation work, but I would invest if the valuation were X.”

Despite high valuations, it’s still possible to make money in angel investing. If you can’t make money in tech, you can’t make money anywhere. 

Anecdotal valuation data

Valuations for pre-traction companies between 2005-2010 were $1-5M pre-money for the first non-friends-and-family round. Funds that invested during this time period made 4x-100x returns.

These valuations moved to $4-6M pre-money after 2010, with some demo days in the $8-10M range. This likely cut returns by 2/3 or more.

5. Back $0B companies

To quote Vinod Khosla, invest in “$0B companies” that could be worth $1B tomorrow.

Focus your attention only on companies with the potential for a 100-1000x return. Otherwise, pass.

Without these large exits, your portfolio will not achieve a venture return. 

6. Judgment about markets is important but overrated

Some markets are obviously bad and should be avoided. But judgment about markets is less important than you think, because there is so much luck and randomness involved. Companies can do hard pivots into new markets (Twitter, Slack and Instagram).

Judgment is not about doing a lot of research, digging and homework. By the time you figure it out, you will have missed the deal. Instead, learn a few markets really well.

Of course, you will learn about new markets over time. But learn a few markets really well. Buy all the products and try them.

Find the best scientists in the market and invest in them. They can help you with research on your next investment; this is an unfair advantage. 

Read research papers then call the grad students who wrote them. Waiting to learn about new markets on TechCrunch is too slow.

7. Invest only in technology 

The best returns come from investing in technology companies. Avoid companies that don’t develop meaningful technology (either software or hardware).

The 5 largest companies in the S&P 500 (Apple, Google, Microsoft, Amazon, and Facebook) are all technology companies. The largest private companies are also technology companies. 

There are exceptions like Dollar Shave Club. Their early investors had good returns. But, as a rule of thumb, you should only invest in technology.

8. Some of the best investors have no opinions

“I have no idea what’s hot. But I’m certainly always listening. Big Dumbo ears. Just listening.” – Doug Leone, Sequoia

Some of the best investors on the planet have no strong opinions about a particular business. They try not to project into the future, so they can listen intently in the present.

Almost any entrepreneur will be smarter than them in their market. The investor’s job is to listen and decide whether the founders are smart, honest, and hard-working. 

These investors don’t fall in love with a business. When it comes time to do a new round, they re-evaluate the business from scratch and ignore sunk costs.

If you’re thinking about all the great things you could do if you were running the business, you’re going down the wrong path: you’re not running the business.

If you are telling the entrepreneur what to do, don’t invest. Thinking like an investor is different than thinking like an entrepreneur who is determined to make a business work.

9. Incentives make for bad investing advice

Incentives influence the advice you get from VCs, lawyers, incubators, and everybody else. Everyone serves their own interests first. The best source for angel investing advice is other angels and founders.

People are generally well-meaning but, in the words of Upton Sinclair, “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!”

10. Play fantasy football

Build your instincts by looking at startups without investing. Your instincts are what you really use to make investment decisions.

In the old days, you had to work at a VC firm to see dealflow. You had to make a few investments and lose money before getting good judgment. John Doerr called this “crashing a fighter jet.”  First you lose $25M, then you have some judgment.

Now you can get judgment without crashing the fighter jet. You can see dealflow from your friends, your incubator, demo days, and AngelList.

You need a lot of data to build up your instincts. Track your fantasy portfolio and anti-portfolio. Write down what you like and dislike about each deal and see how your judgment develops over time.

11. Power beats contracts

Contracts can be renegotiated. You will be pressured to renegotiate your investment by founders and VCs. If you’re alone, you won’t have the power to fight back.

Contracts are written for worst-case scenarios, so people can’t outright steal your money. Suing people is bad for your dealflow. So real-world decisions are usually based on power.

If you’re the only seed investor in a round, you can get screwed. There aren’t enough co-investors to make a ruckus if the company wants to:

  • Recap and start over
  • Raise the cap on your convertible note
  • Give your pro rata to a new investor

If you’re alone, you won’t have the power to fight back. The startup and their new investors can pressure you to renegotiate. So don’t be a herd animal when making an investment decision, but move with a pack when you do. 

Dharmesh Shah, Founder and CTO at Hubspot

The Hustle

Dharmesh Shah is most known for co-founding Hubspot (Market Cap: $37B) and writing its initial seed check of $500k. What many don’t realize is Dharmesh is a prolific angel investor in companies such as Coinbase (Market Cap: $65B), Okta (Market Cap: $34B), and Angellist. Here are his angel investing lessons. 

1. Not all investments will be 20x+ hits, but some should be

Your returns will come from a small percentage of companies creating really large (20x+) returns — not by trying to make 2x returns on a majority of them.

The math just won’t work that way.

Venture capitalists know this well. Your returns come from the big hits not from a bunch of smaller hits. If you invest in companies that all have a high probability of at least a modest return, you’re not going to make enough return to have warranted the risk.

Given the above reality, most (if not all) of your investments should have an opportunity for outsized return.  If you “hedge” and pick companies that have a chance for 2x-5x — but a low probability of failure (i.e. you get your money back), you will not succeed as an angel investor.

So the key to really winning this is having at least a couple of those high fliers in your portfolio — let’s say 1 out of 10.

The way to maximize your chances of this happening is to make sure that all or most are at least trying to create that kind of company.

Nothing wrong with those entrepreneurs that are not trying to create those kinds of companies — but that’s what you should mostly be betting on (unless of course, you’re seeking something other than financial return).  

So, plan for 9 out of 10 not being big hits, but the ones that do will make up for the rest.

2. Picking potential winners are only half the problem

Identifying the potential winners is only part of the problem. A hard one at that. 

The rest of the problem is being able to invest in the companies that you think are potential rocket ships. Often, these deals will be competitive. Plus, these days, there is early-stage VC in the mix too.

To stand out, you have to have some credible story as to why they should take your money vs. all the other money they have access to. The story will vary, but there needs to be one.

Here’s my story: I’m extremely low maintenance and always side with the founders…always. I will not get in the way. I have a relatively strong online following, which I can use to gently at least talk about the company, amplify company announcements, help with Product Hunt, etc.

Related tip: One way to increase your odds of getting into a deal is to use the product (if you can).  As a paying customer. Respond to the founder’s request for feedback (the best ones always ask their customers how things are going). 

3. Check Size

When I started, my check size was either $25k or $50k (I increased those in later years) based on what I thought of the company. 

Let’s call these L1 (lower level) and L2 (higher level) investments. The amounts are not important for this particular insight.

I quickly learned most of my big outcomes came from the L2 investments.

The lesson here is somewhat subtle. If my brain is telling me to make an L1 investment, it means I’m not sure of the deal and I’m trying to minimize my losses and hedge my bets.

Sometimes these work out but usually, the ones I’m excited enough to make the L2 investment in are the ones that work out. Your gut is your best friend.

When you start angel investing, you will be presented with opportunities to invest in startups of family or close friends. You may feel a “tug” of obligation (or guilt). 

That’s OK.

It’s up to you personally as to whether you want to support those folks. But, the L1 or L2 rule still applies.

If you invest, but you’re trying to go in for the lowest number you can (L1 or below), it’s a signal that you’re not a believer yet. That’s OK, but it’s better to go in with your eyes open.

4. Too little or too much is sub-optimal

A mistake too many angels make is that they do just a handful of deals ever — and that’s it. 

That’s not optimal. 

You need a big enough portfolio of investments that you believe could be breakthroughs to have a chance at a break-out return on one or more of them. 

Let’s say ~20 deals or so.

On the other hand, doing too many deals too fast is suboptimal.

First off, you want some of the data from your early investments to be “training data” for your selection algorithm.

You’re not going to get conclusive data for some time (i.e. exits) — but you will get a sense for whether the companies you’re picking have:

a) great founding teams

b) can keep driving growth

c) treat their investors respectfully

d) can overcome inevitable bumps in the road

For example, I’ve talked to new angel investors who say they’re going to do 30 deals a year or so, that’s too much — especially early on. You should start slowly, learn and then scale up.

5. Bigger Checks — Less Competition

Although the valuation does not vary based on check-size, your outcomes do.

Here’s something I learned: The “better” companies (better because founders have done it before, idea is compelling enough that they have lots of interest, they went to Y Combinator, etc.) will be able to choose their investors.  Especially if they’re including angels. And, they have all learned that cleaner cap tables (that’s basically a spreadsheet that shows who owns how many shares) with fewer investors are better.

It’s better to have 5-10 angels than 50. There’s less cat herding to do.

How do you work around this?

If you try to invest anything less than $25,000 you have adverse selection starting to kick in. It’s simple. There’s a higher volume of people that are willing to write $10k-$15k checks — so, more competition.

If you take your check-size to $50k-$200k, you will get into more deals, and those deals will, on average, be better. Of course, you need to balance the larger check size with the fact you need a decent-sized portfolio. This is probably why you should have at least a million dollars or so in “investable” (i.e. losable) assets. If you do 20 deals at $50,000 a piece, that’s $1M.

6. Success begets success

Like other areas of life/business: Success begets success.

Once you have a handful of these high-flying companies in your portfolio, it’s easier to get more.

When you’ve made 5, 10, 20 investments, you develop a bit of a “track record”.

You’ve demonstrated that you’re not just a noob. That you’re not  going to fret over every bump in the road and call the founders when growth flattens or they’re struggling.  (In all my years of investing, I have never once called a founder because I was concerned about the business going south).

7. Speed is a feature

Part of my “brand” as an angel investor is that I make quick (usually < 24 hours) decisions.

Founders LOVE that.

Especially if you lead with:  “I’ve been a founder myself and I don’t want to waste your time — you’ve got better things to do than waste time waiting on me.”

Fun fact: If I were to ever start an “official” early-stage venture firm (which I decidedly do not plan to do), I’d call it Speed Round. Also, I own SpeedRound.com (you know, just in case).

Lesson #8: Don’t let your excitement cloud your commitment

There might be cases where you’re going to be more involved (because you’re passionate about the idea, love the founders, etc.).

That’s OK.

But, you should limit these and not spread yourself too thin. It’s easy to say “yes” early on — but remember, you’re going to be in these deals for 5-10 years.

Lesson #9: Where are you going to invest?

You’ll need to make a decision as to whether you confine yourself to your local region/country or whether you’ll invest elsewhere.

It’s partly a personal decision and what I’m about to say is controversial:  I think there is massive opportunity globally — I think great companies are being built everywhere. But, as a solo investor, I know that making investments in countries outside the U.S. is a Pain In The Ass from a paperwork and bureaucracy perspective.

It’s one thing the U.S. got right — starting companies and making investments is relatively easy here. It’s one reason why many savvy startups have at least a tiny presence in the U.S.

8. Outsource the time suckers

The work involved in being an investor is marginal (and at your discretion), but remember that it’s cumulative. As you get to 10, 20, 30+ investments, many will start having follow-on rounds, wind-downs, and other things that need to be addressed and paperwork to be signed.

These can add up. At some point, you’ll likely need somebody to help with just the paperwork and wires and such.

If I had to do it over again, I’d have outsourced that stuff sooner.

9. Side with the founder(s)

Don’t get into the habit of negotiating valuation and terms and such. It’s unpleasant and it’s nicer to always be on the side of the founder.

In the grand scheme of things it’s not worth negotiating.

Here’s why:  The outcome for most companies will be bimodal.  Many will simply fail and you will lose your money.

That’s alright, it’s part of the game.

Those that succeed will (hopefully) be BIG hits and whether you were able to negotiate the valuation down 25% isn’t going to mean all that much. But it *will* impact the speed and quality of your deals.

Be known as being founder-friendly — it pays higher dividends than trying to decide on what a “fair” deal is.

AND one last thing since we’re talking deal terms.

A lot of deals you do will end up being convertible notes and SAFE docs (made popular by YC). They’ll often have high valuation caps — or sometimes no cap at all. Generally, this is not investor-friendly, but it’s life in the big city. Don’t sweat it.

Romeen Sheth, Angel Investor and CEO at Metasys

Romeen Sheth is somewhat new to the angel investing circuit, but has built a strong brand for himself over the past few years. He’s made several notable investments including Career Karma, Republic, and Boom Supersonic. Here are his angel investing lessons. 

1. Ownership reality > ownership mindset: The earlier you think of yourself as an investor, the better. Investing in startups is a cheat code to participating in the future with asymmetric upside. Worst case, you lose 1x your money; best case you 1000x it.

2. Invest in founders that are better than you: When you’re floored by a founder, work with them. Period. If you’re with the right people you’ll either (a) make a killing because they’ll figure it out / see something you don’t or (b) learn a ton and develop a killer network.

3. Always play the long game: I worked with a Founder for months before getting to invest in the company. If you add value, the Founder wants you in. This ecosystem is also really interconnected. I got into another oversubscribed deal this year because of a reference from that same Founder.

4. Break down investing into 3 phases.

Phase I: Did I see the company? Speaks to my connectivity

Phase II: Did I say yes? Speaks to my judgement

Phase III: Did they say yes? Speaks to my value

Hone in on all 3 and figure out where you’re weak / strong.

5. Surround yourself with people that are world class: Arjun Sethi has been an amazing friend and mentor throughout my angel investing journey. The best scenario when angel investing early on is actually not about the $; it’s about learning a system.

6. Do the work: Get the deck, research the space. I’ve heard 100 pitches this year. You get better at pattern matching / spotting obvious flaws; but you will find yourself on the wrong side of a go / no go decision if you carry mistaken assumptions into the room.

7. You can diligence yourself out of literally every deal: It’s a herculean effort for a startup to succeed. If you just focus on “what can go wrong”, you will literally say no 100% of the time. Instead ask yourself, “if this goes right, how big can it be.”

8. This is the only asset class where the Founder also picks you: It pays to be genuine and helpful. Startups aren’t an asset you can indiscriminately dump capital into. Founders have a say on who they want to work with. This bar for the best deals is pretty damn high.

9. Analysis paralysis is fatal: You have to be comfortable moving quickly and dealing with imperfect information or angel investing is impossible. There were a couple awesome deals (in retrospect) where I could have invested, but fell into analysis paralysis and missed.

10. This really is an incredibly exciting time for tech: There’s a lot of noise about how there’s too much capital sloshing around. I think there isn’t enough capital moving around. To believe the ecosystem is overcapitalized is to believe that human creativity is fully tapped.

Hunter Walk, Investor at Homebrew 

Hunter walk is the founding partner at Homebrew.vc, a well known Venture Capital firm based out of San Francisco. Hunter is known for his investments in Chime (Raised: $2B), Finix Payments (Raised: $96M), Cruise (Acquired $1B). Here are his lessons learned angel investing. 

Sin of Ego: Never make an investment as an angel believing that you can be the difference between a team succeeding and failing. A couple of times I encountered very likable first-time founders who were operating in an interesting problem space but lacked strong product instincts or experience. Should have passed and wished them luck, but instead an internal dialogue started. “Hunter, you’re a ‘product guy,’ just coach them up and you’ll have a huge winner on your hands.” Next thing I knew hands were being shaked and wire transfers sent. And the investment pretty much went to zero within 12–24 months.

As an angel investor you can certainly be helpful, and perhaps even de-risk a specific question or problem the founders face, but you aren’t on the org chart, aren’t spending enough reps to be the product manager of a product-led company. Your mileage may vary, but believing you’re the difference between a company succeeding and failing isn’t an investment thesis. Sure, if it’s a problem area that’s a personal mission for you and you want to spend a disproportionate amount of time trying to help them figure it out, go ahead, but know at that point you’re making an emotional, not financial, decision.

Sin of Enthusiasm: Summarized as “shut up and listen to the founders describe how *they’d* build the company/solve the problem.” You know when you really hit it off with someone and it’s just an amazing jam sesh? Like you’re just finishing each other’s sentences? Feels great right? Well, if it’s in the context of an angel investment it might not be. Did you walk away excited because of what they said or because they agreed with you? Do you have a sense of how they problem-solve? How they want to build this company? Or do you just have a notion of how you’d do it? Well it’s not your company. It’s theirs. And before you invest it’s probably better to understand how they want to build it, since, well you know, they’re going to be building it.

In some ways the above two mistakes are sides of the same core principle: don’t invest in people because of your ideas or your capabilities, invest because you believe they are capable of building something amazing. Then if your help simply gives them the chance to move faster with a high probability of success, you’ll have more than earned your spot on the cap table.

Sin of Social Proof (unless it’s your specific strategy): Some folks will tell you the best strategy as an angel investor is simply to find a handful of great investors and get into every deal they do. If indeed you can execute this it would seem to be a reasonable way to try and match their performance. But if you’re *not* following this sort of playbook, my advice is to not take the presence of ‘other smart people’ in the round as evidence that it’s a good investment. Especially if it’s collections of small checks. And doubly so if you yourself don’t think it’s a solid opportunity. I certainly had my one or two “eh, I’m not sure about this guy” moments where I still wrote a check because of the heat around the deal. You know what, those were incredibly disappointing experiences. And I should have trusted my judgment. So my half advice is, if you want to train on social proof, go all in, but otherwise trust your judgment at the end.

That was a lot...I know. But absorbing even a few of these lessons can have an incredible impact on your decision making down the road, helping you ask the right questions, and ultimately pick the right investments.

See you next week! ✌️  

Callum 

Follow me on twitter at @callumjbooker

Follow EPO at @investepo