Angel Investing Sucks!

It’s vogue these days to have “Angel Investor” someplace on your LinkedIn profile.  It’s on mine.  But if I think about it, I might as well also add in that I’m stubborn, overly optimistic and perhaps uniformed.  That’s because ‘Angel Investing Sucks’.

Deal Flow – As someone who works for a venture firm, chances are I see better deal flow than the average person.  But even with that advantage, I’ll tell you that the deal flow I see is mediocre.  I don’t spend all of my time looking for deals.  I don’t keep a database.  I don’t spend enough time in silicon valley.  I don’t know enough other really high quality angels.  In short, getting good deal flow is hard work.  Chances are that all these LinkedIn profile folks aren’t doing the work required – I’m pretty sure they are not.

Let’s be clear, good deal flow is the engine of successful Angel investing!  For all the entrepreneurs that read this blog – I know there are 1 or 2 of you – that’s because most startups fail.  And by fail I mean close-the-doors, out-of-business kind of fail.

Diversification – When I was studying for my CFA I learned that an individual could diversify away nearly all company risk by choosing 7 to 10 stocks in different industries with different profiles.  That’s public equities.  Because of the risk characteristics of the angel asset class it takes 20 to 25 investments to eliminate company risk and approach the average asset class return. Think you are getting good enough deal flow to participate in 5 deals a year for 4 years?  I doubt it.

Holding Period –  Here’s some more bad news – your failures will fail before your winners will win. What I mean is if the idea you have invested in is bad, the company will usually close it’s doors within a couple years.  On the other hand, if an idea is good it will take a long time for the company to fully realize success and for the investors to get a payback.  So assuming that some dedicated angel someplace got his 20 bets placed  The losing bets from the first two years will begun to go bust while the winning bets won’t have started to pay off.  Result: an Angel will have done everything right so far and will literally be in a negative cash position.  Try explaining that to your husband or wife or mother-in-law with a straight face and total confidence that this hard work will pay off.  The average holding period for an angel investment in the US is 9 years – and the market is totally illiquid.

Amount – Part of getting good deal flow is actually writing checks.  If you sit on the sidelines you won’t get to see good deals because nobody will show them to you.  The average check size for an angel investment is $25,000.  You can write a smaller check or join a syndicate but… you won’t be considered serious and you won’t see good deals. Doing the math an angel investor must be willing to invest about $125,000 a year into this assets class with the possibility of losing it all.  Even if you put 20% of your money to work in this asset class the implication is that you have over $600,000 to invest in a given year.  If so please email me!  Just kidding.  You get the point – only real players should play.

Dilution – So you backed the right company.  Super exciting. Now as the company starts to grow it will need more money.  So in order to keep your 2% ownership – you’ve got to write another check.  Usually angels don’t do follow on investments.  Oh yeah, and the valuation of the company will have gone up so the second and possibly third check will need to be bigger.  By the time it’s all said and done, you will probably own .25 percent.  If the company is sold for a billion (like Yammer) – no sweat.  Even if it isn’t you will still get a nice return… just not an “I’m gonna retire” type return.

Other – There’s bunch of ‘other’ hurdles that can get in an Angel Investor’s way.  I’m just going to mention them – otherwise this blog will go on for too long.  Keep in mind that an angel needs to be an accredited investor, needs to do good diligence, needs to understand terms sheets and needs to understand boom and bust cycles. Trust me, this is not stuff you have in your Finance 101 notes.

Pot Of Gold – Here’s what you get… 22%. Yep.  Exciting right?  You could have done nothing, put you money into the S&P500 and get an average return of 15%.  Or you can do all the work, all the nail bitting, spend all the time and get 7% more.  I’m talking devote-your-life to this kind of work and get 7% more.

Would anyone in their right mind do this? They shouldn’t.  That’s because… Angel investing sucks!

5 comments
Jeff_Miller
Jeff_Miller

Great post, especially about Holding Period.

 

Using 15% as an estimate of the avg return on the S&P 500 is way too high, though. Depends heavily on the time window.

sbberg1
sbberg1

 @Jeff_Miller Because the angel investment class holding period is so long you have to use really long holding periods for the S&P500.  In this case I used 20 year holding periods. The source is Venture Economics, HFRI Equity Hedge Index.  Thank you for reading it.