Here I will highlight the many real reasons angel investors join us, as well as explain startup investment strategies that are broken into 2 categories - risk management and value creation. Before we get into angel investor investment strategies, let's look at why we got into startup angel investment.
There are many reasons why investors join us. Some investors want a challenge in life by helping founders solve huge problems. Some want to give back to the entrepreneurial community by guiding new entrepreneurs. Some want to increase their investment prowess by learning from other great investors. But none are in it purely to make a quick buck.
Non-Monetary Reasons for Angel Investing
Our investors are sophisticated and are not chasing after money anymore. In a weird way, money chases after them. They have proven themselves successful in life. Now, they are pursuing the top level of Maslow's Hierarchy of Needs - where they are now pursuing their inner talent and creativity fulfilment (in other words, to do what makes them happy).
Monetary Reasons for Angel Investment
Angel Investors know that wealth preservation is one thing, and that wealth creation is another matter. To preserve wealth, it is all about hedging against inflation plus generating enough passive income to sustain one's lifestyle.
To create more wealth, the usual safe & conservative investments won't be able to do the job well. This is where high risk, high return investments like startup or angel investment comes in.
Here are the aggregate numbers of angel investing for those who want to test their investment skills:
20-25% Annual Return is the average over 5-7 years, for a total of 2.5X capital returns average (US statistics). Compared to other asset classes, Stocks give an average of 6-7%, and 3-4% for Fixed Deposits (varies across countries). This makes startups an asset class that is perfect for the high-risk portion of an investment portfolio. It is generally recommended that it be no more than 5-10% of a high net worth individuals' net worth.
Angel Investment also gives investors much more control and transparency vs. investing into VC funds. You get to choose what you invest in, learn more about businesses, and via mentoring, learn a lot more about business from a different perspective. There is also less cost vs the typical 2% annual fees (on initial investment) and 20% carry fee (on exits) that VCs typically charge. That adds up to a huge percentage considering fund terms are typically 5-7 years.
If you've heard about 500 Startups, they are popular among the industry for employing this strategy. They invest in anything and everything where they see potential. They take it as a numbers game (luck or probability, however one can see it) betting that the successful startup exits will cover all the money-losing startups, plus give a good return. While the math does work out, it depends on successful startups churning out a minimum 50X return (more if they are lucky), and 10% of the portfolio hitting these return numbers. This strategy also depends on getting back money from startups that are not dead, and are able to pay back some of the investment.
In all asset classes, diversification is a must-do strategy - be it stocks or bonds or property. Having all your eggs in one basket is never a good idea, as Warren Buffet himself said so.
Diversification is surely needed in startup investment, but over-diversification can also be bad as it reduces the average returns as you diversify more. However, it does get you closer to the 25% average returns! By diversifying just enough, an investor is more likely to hit a big one. Typically we advise our angel investors to invest in 10-20 startups to have a reasonable chance of hitting a big one. Depending on your portfolio size, it may or may not make sense to invest in more than 20. For example, if the minimum you can invest is $10K in general, then you will find it hard to split to more than 20 startups if you've allocated $200k to invest into startups.
A good methodology for startup selection is developed over time. It is beyond just evaluating the problem, solution, market, product, traction and financials. The timing of the industry and the valuations also matter. More importantly, the founding team and your ability to add value matters more.
Joining an angel investment group or network has many benefits. You learn more from each other. You get more deals and better deals at that. You have access to more expertise among each other - allowing the startup to benefit more from investors' knowledge. This often creates value, as I will explain in the next section below.
There are many types of angel investment groups;
The best mentors create value by 80% listening and 20% sharing. We have seen mentors guide startups to find their own solutions - and this might just be the best way to do it. When asked why the mentor said he will never understand as much as the founder what problem they are facing. Of course, the experience is still shared from mentor to mentee - but every situation is different.
So, how does it actually create value?
Mentoring, being a very complex art form, is able to give founders clarity when needed. Founders have to make a huge number of hard decisions in their lifetime, and sometimes it can be quite lonely and confusing. That is why at Nexea, we gather actual successful businessmen to mentor the new generation of entrepreneurs. Only they can understand what problems and pain these founders are going through. Therefore, the chances that they are able to successfully guide founders is much higher. We have seen our mentors guide startups out of problem after problem. Problems that if left unsolved, would have left startups dead in the water.
Some other investors introduce their startups to their networks that can help. Recently, one of our lead investors brought in a large company ready to pump in business >30X their current revenues. Another investor of ours introduced a company that is interested in acquiring a startup. We also have had investors make introductions for startups to merge to immediately transform from 2 local startups to a regional startup. That is all in the realm of value creation.
Let us know if you agree/disagree with the strategies above. If you have another strategy, even better! Let me know and I will include it above.
If you are an Investor looking to help startups in any form, do get in touch!