“You get to play God a little.”
Previously, we discussed the pros and cons of participating in crowdfunding activities when the JOBS Act is enacted. However, if you’re an accredited investor, defined by the SEC, among other definitions, as either having a net worth of $1 million or an annual income of $200,000 for individuals or $300,000 for couples, then your opportunities to potentially catch rising stars at the ground floor increases, as you’re able to invest in private offerings (including hedge funds) and don’t have some of the limitations that the S.E.C. (the Securities and Exchange Commission, not the Southeastern Conference…go ACC!) puts on regular retail investors. When you hit that $1 million threshold, you’ll also probably be exposed to some more opportunities to invest in these small companies than you might not otherwise be exposed to.
Just because you can invest in angel opportunities, does it mean that you should?
The numbers don’t bode well for angel investors. According to the Wall Street Journal, only 7% of angel investments went up tenfold. In general, angel investors are trying to play venture capitalists, except that venture capitalists have institutional funds backing them, not to mention expertise and networks that all but a few angels lack.
Are you still itching to try your hand at being an angel investor? Here are some tips to think about before you stroke a check to a company.
- Investigate joining an angel investing group. According to Dr. Scott Shane of Case Western Reserve University, accredited investor angels affiliated with angel groups and willing to talk about their investments–this is important because there is certainly survivorship bias skewing the numbers up–showed a return on investment, in 2008, of 19.2%. Of course, you’re not guaranteed that return, or any return at all, but it does seem that angel groups, probably because of the industry connections and experience they have, do perform better. The price will be an annual management fee and probably a fee to join the group as well, but if you’re bound and determined to be an angel, this seems the best way to do it.
- Keep your investments small. According to the aforementioned study, in 2006, the average angel investment from an angel group was $31,457. If you’re just above the $1 million net worth threshold, then that will only allow you to take one or two cracks at angel investing if you invest according to the rules I set forth for swing-for-the-fences money. Given that most of these investments will flame out in under five years, it’s better to diversify your risk with smaller bets.
- Don’t fool yourself into thinking that you can materially affect the outcomes of most investments. While you may have been successful in a certain field, most of the angel opportunities will not come from the areas where you have expertise. You may be able to impart some general wisdom, particularly if the management team is young or has a skill gap where your experience matches, but don’t expect to come in and run things. That’s what the entrepreneurs are doing. They’re looking more for your money to help them get off the ground (if they can) than for you to come in and run things. If you have to run things, start your own company instead. You’ll be much happier at the level of command and control that you can have.
- Shoot for quicker, lower payouts. As mentioned previously, only 7% of all angel investments get 10x or higher returns. If you set your expectations lower, set a timeline on being paid out, and make it easier for the next round of funders to take you out, then you have a higher likelihood of actually experiencing the exit event.
- Do your due diligence. If you’re being asked for money to help fund a venture, then you have every right to examine the company’s books and to grill the founders about their plans and what they’re going to do with your money. You’re not obligated to give them money just because they have an idea which they think is good. Remember, they probably need the money more than you need an opportunity to invest it, so don’t forget where the negotiating power rests. Furthermore, as Dr. Shane points out, the estimated number of angel investors is between 331,000 and 629,000 people, and between 50,700 and 57,300 companies receive angel investments annually. You can play hardball, because you’re likely not going to be bid out of an opportunity unless you are in an area which has a flock of active angels.
- Try to negotiate for sweat equity rather than paying money. If you have specific expertise, experience, contacts, or abilities to offer, see if you can work out a deal where you offer those skills and capabilities to the company in exchange for a piece of the action rather than putting your own cash into the deal.
- Use angel investing as an opportunity to pay it forward. You most likely got to your situation in some part because of mentorship that you received over the years. I’ve been fortunate to have many mentors throughout my time, and I am grateful to them. Angel investing is an opportunity to provide mentorship to the next generation of business owners, and, if you’re lucky, you might get something besides warm fuzzies back in return. At worst, you might get a little neat schwag out of the deal. The office at the company I co-founded was littered with t-shirts and mugs of failed startup ventures.
Regardless of your intentions as an angel investor, it’s prudent to remember that your chances of hitting a real, meaningful, life-changing home run are very, very slim. I know a few angel investors, and I can say that, almost to a person, those angels are not rich as a result of their angel investments. They got their net worth some other way and, to be blunt, mainly dabble in angel investing as a side hobby. If you’re going to be serious about angel investing, it’s wise to keep your expectations in check and to do your homework before you fund the next great thing.
Have you ever invested as an angel in a company? What were your experiences? What advice did I miss? Tell us your thoughts in the comments below!