Learnings from a 6x angel investment portfolio

I debated writing this. Partly because I didn’t want to jinx my portfolio. Partly because my gains are all on paper anyway. And partly because when I did my angel investing, it was at the beginning of my investing career when I really didn’t know what I was doing. Hah.

Nonetheless, I do think I’ve had some great learnings that are worth sharing with entrepreneurs and would be angel investors.

1) You don’t need to invest a lot of money to become an angel investor.

I think a lot of people think of angel investors as super rich, investing $25k-$100k at a time. This is what I thought too when I was an entrepreneur. I thought, “Someday, when I get to be super rich, I’ll start angel investing.”

Later I learned that actually a TON of entrepreneurs in Silicon Valley angel invest. And they are not even that rich. How is this possible? I would later meet a number of entrepreneurs who invest $1k-$5k checks into startups.

That was a mind blowing discovery.  You don’t need to be filthy rich to angel invest.  Just like how there are now microfunds. There are microangels.

2) Being an angel investor helps you network

The second learning was that entrepreneurs who are angel investors can mingle and network with fellow angel investors. This allows you to build friendships and rapport with other investors who have more money than you and guess what…they can invest in your company and introduce you to other investors!

This is a great strategy for raising money that I wish I had known when I was building my company.

3) Your small check size doesn’t matter if you are value-add.

You might wonder why any entrepreneur would even accept such a small check of $1k. If you can be value-add, then that really helps you win deals. Because more than money, people want help. Especially at the earliest stages. Think about it — money buys help, so if you can provide help for free, then that’s huge.

Do you know something about engineering? Marketing? Sales? Design? Do you have a good network? Can you provide good feedback on things like marketing materials / landing pages / pitch decks? These are all value-added activities at the earliest stages that help you win deals when you are writing small checks.

4) Your reputation matters most.

A lot of new investors inadvertently are a pain to work with. I hear stories of people who take 5 meetings for just a $25k investment. Or stories of investors who require tons of due diligence for a $10k check, including 5 year spreadsheet projections and extensive business plans.

If you’re new to the game, set expectations for what your process will be like. Be transparent. How many meetings do you typically need to make a decision? Do you want to mentor the company first before deciding? Whatever it is, be transparent with your process so that the founder can decide whether or not he/she wants to go through with your process.

Reputation matters and word gets around very quickly. This will set you up for future deals.

5) Work with founders lightly to learn

Like everything else, investing requires practice. And the only way to practice is if you have a feedback loop. You need to work with your founders after investing in order to better understand what type of company you picked and understand what’s going on in the business / with the founders.

Make sure you are not a nuisance. See above. You don’t need to work with the founder forever. It could be a few meetings to help them with their deck. Or it could be a few meetings to help them with their website. Or UX of their product. Or product testing. But you need to interact with the founder so that you can get better at picking companies.

An alternative to becoming an angel or microangel is to work at an accelerator or incubator.  Or even mentor as a volunteer for an accelerator or incubator.  You will learn a lot about teams and different kinds of businesses.  Accelerator programs see a TON of deal flow and invest in a lot of founders, and you will learn a LOT about investing without risking your own money very quickly.

6) Build a large diverse portfolio

VCs often debate whether you should have a “spray-and-pray” portfolio vs a “concentrated portfolio”. Having built both kinds of portfolios before, I think building a “spray-and-pray” portfolio is the easier strategy to start with.

What do these terms mean?

“Concentrated portfolios” — these are portfolios that have a few number of companies — say 10-20 in total. So if you are allocating say $100k in total to angel investing, you might put $10k into 10 companies. Most Sandhill VC funds are in this camp.

“Spray-and-pray portfolios” — these are portfolios that have a lot of companies in them — certainly 20+ and some cases 100+ companies. So if you are allocating say a total of $100k to angel investing, using this strategy, you might put $1k into 100 companies. YCombinator and 500 Startups are examples of this approach.

A lot of investors have strong opinions about which is the better approach. Having looked at the data, you’ll see big winners and losers utilizing each strategy.  So, like everything else, it’s really a matter of how good and lucky *you* are.

I think the spray-and-pray portfolio strategy is easier to start with, because there’s room for a lot of error.  Your initial investments will likely be horrible, because you won’t know what you’re doing.  This method gives you a lot of shots at trying to capture a super huge winner, much like how YC has Airbnb and Dropbox.

Statistically speaking, if your sample size of deal flow is “generally good” and you are an “ok picker”, you can at least get to at least breakeven with the spray-and-pray strategy.  A former colleague of mine Matt Lerner, simulates this nicely in a post on the spray-and-pray strategy.

The tl;dr is that in essence, if you have a portfolio of roughly 100 companies, you should be able to pick at least one company that is 100x+ return or higher to get your portfolio to breakeven.  For each additional startup that is 100x+ return, your overall portfolio will yield an additional multiple.  E.g. if you have 3 100x+ returning companies, you’ll have roughly a 3x portfolio multiple.

The question about this strategy that I often hear is whether it is possible to generate say a 50x returning spray-and-pray portfolio?  And the answer is yes – YC is a good example of that.  To achieve this, you must have at least one deca-unicorn (like Airbnb or Dropbox) in your portfolio.

So if you go with the spray-and-pray strategy, you can start to build this over a few years — invest in say 5-10 companies per year to end up with 50-100 companies in your portfolio.  Each year, as you get learnings, hopefully your dealflow and picking gets better.

7) Be patient and don’t freak out.

You will want to freak out in the beginning, because you will see a lot of seemingly losses. This makes sense because the companies that can’t make it will die earlier than later, and the big winners that will return your portfolio won’t get to maturation until years later. So you need to have some faith and a strong stomach. You won’t see your portfolio start to inflect for years!

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I was a microangel from 2014-2017 (I no longer angel invest because I now run Hustle Fund).  I invested in 7 companies over those 3 years with $5k checks in 5 of them and $10k checks in 2 of them.  3 of these companies shut down more or less before I had paper gains on the others.  So it was incredibly nerve wracking, because I felt like I was losing all my money!

8) Be prepared to lose all your money!

All of this said, you can always lose all your money. So, be prepared to do so. Angel investing is risky, and most angel investors (and VCs!) do not see positive returns. Don’t part with more than you can handle.

And this brings me to my next point.

9) Investing is all about power law — don’t worry about your losses.

In talking with a number of fund managers and seeing data from my own experience, you can basically think about your portfolio companies in 4 buckets.

1) Non-returners
2) Low returners
3) Good returners
4) Excellent returners

Most of your companies will fall into category #1. And that seems scary. But, as you can see from my portfolio, your losses don’t really matter. In fact, if you copy this sheet and play with the numbers, you’ll see that your low returners don’t matter either! Everything is really riding on your excellent returners, which you won’t have many of.

A few takeaways from this spreadsheet of my angel investments (and please do copy this and play with the numbers):

A) You need at least one excellent returner. I often hear angels talking about looking for 10x returns or 2x returns from their companies. As you can see, you need to be shooting for much much higher in your ultimate winners.

B) Your good returners don’t have as much impact as one might think unless you have a whole handful of them.

C) New angel investors worry about the losses and sometimes get nasty with founders who lose their money.  But in practice, those losses don’t matter either.  If you get nothing back vs $0.20 on the dollar, it’s a wash — it’s literally all the same.

Of course, it’s always nice to receive money back from a company that is winding down. I see that as a good signal about the founder — that he/she is looking out for your interests and wants to do right by you. But as you can see, from an ROI perspective, that dollar amount itself in that category really doesn’t matter.

In contrast, seasoned investors don’t care about the losses and concentrate on the potential winners. You need to try to find as many of those 100x+ returning companies as you can — that is what the game is about.  This is something to keep in mind as an entrepreneur — how can you convince someone that you are a 100x+ winner?

D) You won’t know who in your portfolio is the excellent returner(s) when you start investing. And you won’t know for years.

My portfolio is 3-5 years into angel investing, and all of this is paper gains.  So all fake gains right now.  Any one of these companies could go belly up at any time.  The hope is that one of these companies can inch up to 100x real gains. But we’ll see.

10) Start by co-investing with people who have good deal flow

In the beginning, you won’t have a brand or deal flow. The easiest way to jumpstart your angel investing is to find people who do. Find friends who already have been investing for years and have been doing well. You can also invest in funds, who may share their deal flow and pro-rata rights. Or you can mentor at accelerators or co-working spaces.

Once you start generating deal flow, by continuing to invest, you build up a brand over time.

You will want to see a lot of deals in order to start to compare companies to each other. Seeing a company in isolation won’t help you understand if it’s a “good company”.

You need to understand whether the team is in a competitive market — e.g. are you seeing 10 companies chasing the same thing?  Do you place a bet after seeing a lot of companies or do you shy away from the space altogether?

You won’t know if a company’s revenue growth is good or not until you see other companies and their growth.  The other benefit to being an angel-entrepreneur is that you get to see what is “market” as far as competitive spaces go and growth rates go.  You don’t normally get to see that as an entrepreneur.  That helps you understand how your startup stack ranks.

11) Entry and exit points matter

One of my most surprising learnings from investing the last few years is how much entry and exit points matter. I learned that there are a lot of investors that brag about investing in marquee companies that have done phenomenally well and yet have made little to no money because they got into a deal at too high of a valuation and got out at a valuation that isn’t high enough to cover their other portfolio loses and make money.

Unfortunately, as an angel, you have no control over the exit point. You are just along for the startup ride. So you can only control the entry point.

So for example, if you are shooting for 100x+ multiples in your winner(s), then if you are investing at $3m cap on a SAFE, then roughly speaking, you are trying to exit around the $300m valuation mark (or higher!).  If you are investing in another company at $6m cap on a SAFE, you need that company to deliver 2x the exit of the first company, which is incredibly hard.  Note: historically, the number of new companies that get to the $1B valuation mark each year was less than two handfuls WORLDWIDE, though in the last couple of years, hundreds have been promoted to unicorn status in the startup bubble.

So maybe your strategy is to invest at a low valuation.  Maybe it’s to invest in high valuation companies run by high profile founders.  But whatever your strategy, entry and exit points matter.

12) It’s all luck. No one can spot a winner at the earliest stages.

One final thought — angel investing at the earliest stages is pretty much luck.  Anyone who tells you it’s skill is sh*tting you. You can have amazing founders do amazing things and then get run over by a bus or have some regulation come in and break up the party. And if you’re riding on just your one winner covering your loses and delivering big gains for your whole portfolio, that’s a lot riding on one company. Maybe you have a couple or a few of these winners, but if one falters, then that reduces your multiple by a point or so on a portfolio of 100 companies.

So your best investment is probably to buy a magic 8 ball.

Image credit: Gfycat

To recap:
-Risk capital you can afford to lose
-Learn from your investing and improve your thought process and strategy
-Microangels are en vogue and being one helps you access other angels
-Structure your portfolio to diversify enough to increase your odds of capturing at least one big winner (at least 50 companies if not more to get a winner of 100x)
-Keep entry and exit points in mind

Featured image credit: CBS News