A number of years ago, while sitting in a bar in Manhattan, I heard a guy in a suit next to me talking about how he was a part owner of the establishment. Turned out he was an investment banker and regular customer and had put some money in as an investor.
No doubt it was an ego boost to be able to brag to other patrons about being an “owner” of the establishment. Maybe he got a few free drinks when he came in. But what kind of return did he make from his investment?
Angel investing seems cool. Everyone wants to get in on the hot new startup. It’s fun to talk about innovative companies over drinks. But how does it fit into your overall investment strategy?
According to a study by the University of New Hampshire Center for Venture Research, angel investment in 2020 totaled more than $25 billion in more than 64,000 early-stage companies, “with angels as the leading source of seed and start-up capital”. But angel investing is about the riskiest form of investing there is, except maybe investing in cryptocurrencies.
I always thought angel investing was cool too. I felt good supporting fellow entrepreneurs and excited by the prospect of hitting it big. I made my first angel investment in 1998 in a company called AmericasDoctor.com, a precursor to WebMD, that became a major health content provider for the original AOL internet service. The company seemed to have great promise as the demand for online content was exploding.
But after rejecting an offer for a strategic investment from a major media company, AmericasDoctor.com's IPO window slammed shut. Within a couple of years, the company ended up selling for far less than the amount of capital investors had put into it. At their peak, my shares had reached a notional value of $2 million. In the end, they were worthless. Maybe I should have learned my lesson, but that was not the last angel investment I made that lost money.
Angel investing has great allure, but is fraught with peril at every turn. This is particularly true if you are considering investing directly in individual companies rather than through an angel group where there may be more safety in numbers and the opportunity to diversify.
To be clear, when I'm referring to angel investing, I'm not talking about investments by so-called "Family Offices", the investment operations of the super wealthy. Those operations function similarly to venture capital firms, investing large sums, and often employ investment professionals to manage the process.
I'm referring to your everyday millionaire, individuals who are looking to invest $25,000 to $250,000 in a given deal. Those investors often lack the access, scale, clout and resources to do justice to the investment process or influence the company's results over time.
Here are nine reasons why:
Despite the pitfalls, angels remains a robust source of startup capital. I personally decided that I was going to confine my direct angel investing to companies where I have a close personal relationship with the founder or am personally involved in the company to help influence the outcome. That's certainly no guarantee of success, as many of the hazards still apply. But I concluded that there are too many uncertainties to take a blind leap of faith backing companies and individuals I don’t know.
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For those who do want to participate in the seed-stage economy, the best way to do so may be by joining an established angel network or fund. Preferably a fund that pools capital from many angels and invests in a portfolio of companies rather than simply presenting deals for investors to invest in individually through a syndicate.
Partnering with other angels will provide greater access to better deals and more clout in setting deal terms and influencing the company. You will benefit from joining forces with other investors who may have relevant expertise and can conduct more robust due diligence as a group. And considering seed stage companies as an asset class, you are much better off taking a portfolio approach and improving your odds that some of the companies will find success, covering the inevitable losses from the others.
If you want to learn about angel investing, I highly recommend you read Every Business Needs an Angel, by John May and Cal Simmons , two of the pioneers of angel investing groups in the Mid-Atlantic. While the book was written primarily to help entrepreneurs attract early stage capital, it provides a comprehensive and insightful view of the angel investing process.
The pooled capital approach facilitated by angel groups essentially mirrors the venture capital model, with shared risk by all participants and built-in diversification across a portfolio of companies.It's like betting on "red" or "black" on a roulette wheel rather than on an individual number. If you win, your upside is not as great, but your odds of losing your entire bet will be far lower.
Gus Bessalel is the author of the Amazon bestseller and Top New Release,The Startup Lottery: Your Guide to Navigating Risk and Reward. The book is an essential guide for anyone considering a career in startups.
To purchase the book, visit The Startup Lottery on Amazon.
A former Inc. 500 CEO, serial entrepreneur and 30-year veteran of startup life, Gus has a BA and MBA from Harvard University and started his career in management consulting at Bain & Co. He was also the Co-Founder of Compass Pro Bono, a volunteer consulting organization that advises nonprofits. He mentors young companies and entrepreneurs and writes about startups and business, among other eclectic topics.