ANGEL INVESTING 101: An Introduction to Angel and Venture Capital Investing By Michael Gruber – Chapter 5

Chapter 5

Learnings From An Angel (Part 1)
Note: This article was originally written and published for DailyDAC as the fifth installment in a series of articles.

Having gotten active in angel investing over 15 years ago, I felt compelled to provide to share in some of my own personal learnings as well as those that I have learned through my fellow colleagues. As the saying goes, it you want to make a small fortune in a new venture, start with a large fortune! Early stage investing is a high-risk activity, and investors need to be prepared for the potential that an investment can be a total loss. In addition, the likelihood of any particular company being a homerun has a low probability. But that being said, angel investing is not always about making money. It is certainly a large component, but one of the reasons that many of us continue to be involved in such early ventures is not so much the ultimate pay-off, but it is that many of us are intoxicated with the smell and adventure of the creation of something new. The rollercoaster of a start-up is exciting for many, and the very notion of being able to be involved in such effort, and having opportunity to either work alongside, or even pass on experience or knowledge is incredibly rewarding. For those in their later part of their lives, angel investing can become a rich man’s fountain of youth, especially as they will be interacting with 20-something entrepreneurs from multiple companies.

While angel investing can be sexy, and the tenure of people’s activity may be short, I am hoping to quickly provide a few high level concepts to qualified investors in making their investment experience, hopefully more rewarding and successful, and as such, I hope this allows each of you investors t be active in this activity for a long time. Some of these concepts may not be applicable to you, may not be appropriate for certain investee companies, or only a few might work well together, but I believe they provide a good framework for a decision and can drive a healthy combative discussions on the merits and cons for each.

Key Angel Investing Concepts to Remember:
Contact Sport
Do Research
Know Your Leaders
Interact with Investors
Play the Numbers
Extra Firepower
Take Your Time
Surround with Smarts
Open & Frequent Communication
Close to Home is Best
Be Supportive & Giving

Contact Sport: Although much of angel investing is done as a passive activity, your active involvement with a company will typically increase the odds of a success. Getting your hands dirty is helpful. Many times this will be done within an angel investor’s area of expertise, but it doesn’t need to be. The key is that when there are more investors who are willing to go the extra mile to help the companies think through strategic issues, and to leverage their networks, this can help lead to strong potential outcomes. See whether you have a passion for the vision or mission of the funding company.

Do Research: You owe it to yourself and your family to have spent some time researching the company and its market before investing. This does not guarantee that you will make the right decision, but it helps. By even the most simple review, your questions to management, and their responses to those questions will give you a good insight into their knowledge as well as more importantly their reasoning capability. Also, as the investor base for a company is more knowledgeable (and supportive, and smart, and reasonable, etc.), their will hopefully be value-add to the company without an obscene amount of administrative burden in managing those relationships.

Know Your Leaders: Spend time with the founders and key management team, both in business and within social environments, including potentially with their significant other. It is amazing how different people act in different environments, and the information that will be revealed in this situations in mind blowing. Validation of past successes, better understanding of failures, as well as greater insights to external pressures are illuminating to help decide on whether you have confidence in the team within the complicated lives that we all weave for ourselves.

Interact with Investors: In a similar fashion to learning about the leaders, it is helpful to know about the expectations, goals, and ambitions of the other investors with respect to the investee company. In essence, you want to know with whom you’ll be getting in bed, as the decisions of these people will affect you through multiple year life of your investment. Although the prominence of many smaller investors may not make this as critical given your relative inability to effect change, however you will be in a much better position if the investors have similar time horizons as well as liquidity expectations. As shareholder votes on critical matters arise, and as investors utilize their ability to provide support to the company with introductions, this “synchronicity of vision” can become very important.

Play the Numbers: In short, it is better to have a diversified portfolio. Spread your bets across multiple companies, and try to manage the concentration of investments in particular companies. Too often I see times where people have made extremely large investments in a particular company because they thought it had a high likelihood of being hugely successful. These investors either cite their own personal experience in the sector, how hot the sector is, or the promises of near term and large returns by the company. Unfortunately, investors are not able to always pick the winners, and often the ones that we invest the most $ into are not likely to even be those winners.

Extra Firepower: Be ready for future follow-on investments. A company often needs more money than it claims, and as such, as a good investor, you should be prepared to potentially invest in the future, either to provide a bridge during difficult times, or for future offerings. You should do the research, and decide whether a future investment is a proper decision, but you should have the capability if it was needed. As I and many others saw during this past Great Recession, many of our portfolio companies needed to raise capital, and in many situations, the valuations of these companies were dramatically reduced (50% in one case). In the right situations, the ability to make these investments can dramatically increase your IRR. Extra Firepower is closely correlated to Play the Numbers and should encourage you to reduce the first investment in a company, and to then potentially increase your stake over time.

Next installment: Learnings From An Angel (Part 2)

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