Angel Investing: The New Alternative Asset

by David S. Rose '83BUS
originally published in Columbia Business


Angel investing is when individuals invest their personal capital to help finance a recently founded company. Over the long run, carefully selected and managed portfolios of personal angel investments can produce an average annual return of more than 25 percent, which compares well to virtually any other use for your money. Even better, you often get a ringside seat at a venture that is out to change the world, direct access to company CEOs who may become the corporate magnates of tomorrow, and early access to the latest products and services before they become generally available.

However, a large majority of self-proclaimed “angel investors” actually lose money because they do not carefully manage their investments, take a long-term view, or have a clue about how to approach angel investing as a serious part of an alternative-asset portfolio. Here are ten tips to start you on the path of successful angel investing:

1: Be sure you qualify as an Accredited Investor.
 The SEC limits investments in private companies to people who have a steady annual income of at least $200,000 (or $300,000 together with a spouse), or net assets (not including the value of their primary residence) of at least $1,000,000.

2: Have a long-term perspective. Angel investments are completely illiquid and cannot be sold until the company is acquired, which typically takes 5–10 years. This means you must be in it for the long haul and comfortable with no access to your angel capital for a decade.

3: Don’t invest more than you can afford to lose. While statistically angel investing is overall a high-return asset class, each individual angel investment is extraordinarily risky, and most will fail. Experts suggest investing no more than 10 percent of your annual free cash flow into angel opportunities.

4: Invest the same amount in each company. No one opportunity is “less risky” than another — regardless of appearances — so have the discipline to invest the same amount into each company in your portfolio. That’s the only way the statistical Law of Large Numbers works to protect you.

5: Reserve additional capital for follow-on rounds. Every company always needs more money, whether it’s for happy reasons (to fuel growth) or not–so–happy ones (revenue projections were off). Early angels can see their ownership interest in a startup greatly reduced if they can’t fund again when the company needs it.

6: Invest in a large portfolio of companies. Because most startups fail, you need to invest in enough companies to have a good chance of getting at least one “home run.” Most experts suggest that this means investing in at least 20 to 30 companies over the course of an angel career.

7: Be extremely selective in making investments. Whereas venture capital funds typically review up to 400 opportunities for each early-stage investment, professional angels are generally only able to look at 30–40 company presentations before writing a check. Be aware that "all that glitters is not gold" and don’t jump at one of the first pitches you see.

8: Be very careful about valuations. Serious angels understand that for the rare "home run" to more than make up for all the startups that fail, it’s important to aim for a return of 20 to 30 times the original investment on each deal. This can come from an enormous exit, but it is more likely to result from having invested when the startup’s valuation was between $1M–$3M, the national average for a pre-revenue startup.

9: Proactively support your companies. The best angels develop reputations as “smart money,” because they add value to their portfolio companies through wise advice, mentorship, and important introductions to customers and other investors. That said, be sure your help is additive to the company; don’t be a pain in the neck to the CEO.

10: Join an angel group for deal flow, scale, and support. Finally, there’s no question that the best way to get your feet wet in angel investing is to join a professional angel group that is a member of the Angel Capital Association. These groups provide a wonderful introduction to the field, are a great source of angel mentors, and give you the option both to see carefully vetted investment opportunities and to pool your investment with those of other investors, which significantly improves the likelihood of your being a successful angel.

David S. Rose ’83, founder of New York Angels and the CEO of Gust, is the author of Angel Investing: The Gust Guide to Making Money & Having Fun Investing in Startups (Wiley, 2014).