It is no secret that Angel Investors, as an industry, enjoy better than market returns. According to the Kauffman Foundation, the industry average is 2.6x on your money in 3.4 years (individual results will vary widely…and we are about to talk about why!). Out of the 5 – 8 million qualified investors (according to the SEC regulations of $1M in networth excluding your primary residence or $200,000 in annual income), only approximately 320,000 individuals choose to do so (Angel Capital Association, 2016).
At the same time, make no mistake about it, this is a numbers game. The way the industry has matured, Accelerators feed the Angels, and Angels feed the VC’s in a linear path. Every year 600,000 new businesses startup, 60,000 of those get angel funding, and only 3,500 get VC funding. That means there is a 90% down selection by angels followed by another 95% down selection by venture capital firms. That means .05% of all ventures that form receive professional funding from both angels and VC’s. If you extrapolate from longstanding Angel industry results, 50% of the 60,000 fail (30,000), 40% of them return capital (24,000), and 10% return more than 2 times their investment (6,000). So, you are looking for 20 of the 6000 companies out there each year (which are heavily weighted to a few centers of investment) that have the potential to return your capital with profit. As an aside, crowdfunding is growing and will continue to do so, but it is not a major player in this game yet.
Let’s face it, angel investing is not easy. It takes work. It takes time. And, it takes dedication, participation, and collaboration. Second, it takes intestinal fortitude to weather the inevitable losses that come, typically, before the wins. Industry numbers on the process are intimidating. As an industry, Angels return capital from 6 out of 10 investments with one to two exiting companies paying for all the loses plus a healthy profit. In this model, 4 – 5 will be a total loss, 3 – 4 will be a modest return or loss, and the last 1 – 2 will be the ones that pay for the entire portfolio (same numbers as above). Venture capital numbers are, not surprisingly, very similar. It is daunting to watch a great idea in the hands of a passionate entrepreneur crash and burn…and not just one, three to four of them! And, almost inevitably, the ones that return capital are the last to exit. As they say in the industry, , “lemons ripen in two years, but plums ripen in 4 – 7.” So, it is not just one leap of faith. It is a series of leaps of faith in the face of statistically backed failure!
For this reason, the industry recommendation is to make 20 investments over 3 – 5 years to give the best odds of returning 2 – 3 times your capital (Rose, 2014; Merle and Merle, 2015). That sounds simple, but it is deceptively hard. We all want to believe we are smart enough to pick the winners, but that is hubris talking, not financial savvy. So, the first few loses are hard to swallow no matter how sophisticated an investor you are. And, there will always be one that will surprise you that you thought was as sure a bet as can be made. Luckily, that works both ways and one will almost certainly surprise you that you thought was a “walking-dead.”
We embrace the angel fund model because it forces a certain amount of diversity on its members in a healthy way. In this model, angels commit funds into a LLC and a bank account, then vote to invest the money from the fund. A majority vote decides the investment and amount. This forces them to do the smart thing with regards to angel investing: set aside an amount of money and invest it in a minimum number of companies over a period of time. In general, that is $50,000 in 10 – 15 companies over 2 to three years. Some people will balk at the cost of forming a fund, but we have found over time, the cost is no different than joining an angel club. This is the recipe for angel investing success. Players are attracted to funds. They enjoy a unity of mission, purpose, and action. And, they remain engaged throughout the entire process.
So, here are the recommendations for making GREAT Angels:
- Find a like-minded group of people that you want to work with to identify and vet great opportunities.
- Plan to invest $50,000 – $500,000 over a 3 – 5 year period and invest in a minimum of 20 well researched, top-shelf deals.
- Perform a minimum of 20 meaningful hours of research on the team and company with a target of 50 spread across your group (the industry stats show these are critical breaking points for success). (Hudson, 2015)
- Invest in a diversity of markets based on the experts you can reach to assist you.
- Some of your investing should be hyper-local to impact your community.
- Some of your investing should be regional as a rising tide lifts all ships.
- Hedge your bets by casting a wider net through angel fund “syndicates” or online platforms to ensure industry, market segment, and geographic diversity.
The sheer down selection in the industry means you must be VERY selective. You must perform deep diligence on these companies to make sure they have the potential to either be a roaring local success that directly benefits your community or a roaring financial success that precipitates an exit and substantial return of capital. Diversity of markets and of geography is important if you want financial returns. Reliance on like-minded peers is critical to finding and investing in top-shelf ventures. To be a great investor, set a budget and stick to it investing in not less than 10 deals with a goal of 20 over a reasonable time frame. That is the way to beat the odds.
This is published under the Appalachian Regional Commission POWER Grant, PW-1835-M.
Copyright Appalachian Investors Alliance, Inc. 2018
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