Guide to Angel Investing

I’ve been dabbling in startup investing for a few years now. Nothing extraordinary, and I’ve definitely not made it a career, but I have developed a guide of sorts that I follow when making the final decision of whether or not to invest.

This is written from the viewpoint of a single angel investor. Here it is:

  1. Risk: Understand the high risk in angel investing. Mentally, assume you’ll write off all investments as soon as you make them. Invest only what you can afford to lose.
  1. Avoid life-support investing: If a company comes for funding, where the founder says/implies something to the extent of: “fund us or we’re going out of business” – usually gravitate to not investing. Life support investing is a bad idea (not to mention stressful!).

Lean towards companies that will survive regardless of whether or not you invest in them.

  1. Three companies come in for funding:

A – Entrepreneur has the best idea ever! They need funds to build the product.

B – Entrepreneur has the best product ever! They need funds to market.

C – Entrepreneur has a product which shows great traction. They need funds to                    scale.

Everything else equal, investing in C has the most promise.

  1. Follow-up investor: For the new investor, prefer being a follow up investor rather than leading rounds.
  1. Investment hierarchy: First invest in companies with great traction. If that does not exist in the options, then invest in those with great people, followed by those with a great product.
  1. Bet on people rather than product: Early stages, funding is a bet on people rather than product. Products can change more easily than people.
  1. Never invest in something you don’t understand: Doesn’t matter what it is, who is involved, who has invested or how well the market is going.
  1. Entrepreneurial grit matters: Invest in entrepreneurs who show they’ll simply never give up on the company – no matter what. Perseverance is crucial. When things get hard (and in startups they will!), you want someone who has the grit to stick through it to figure a way out.
  1. Scaling: Always think about how the company can scale. If scaling is expensive or hard, lean towards not investing.
  1. Avoid niches: Niche markets are starting points – but that’s it. The ultimate market cannot remain in a niche space. Successful companies need to scale.
  1. Viable business or science project?: Is the company capable of being a business or will it remain a technology/project? Not all technologies can become businesses.
  1. The Fence: If you’re on the fence about a company for a long time – defer the investment.
  1. Entrepreneur’s knowledge: The entrepreneur needs to know more about the space than you. If you seem to know more about his own space – that’s a red flag.
  1. First versions will suck: Products require several iterations of trials and failure to become great. The key is if the entrepreneur/team is unfazed by failure to keep at it despite the obstacles.
  1. What if Google/FB does it?: Assume the incumbent is always going to copy the entrepreneur if he does well. What is his strategy?
  1. Does the product create delight?: Do you feel delighted when you use the entrepreneur’s product or service? If not, at least do the customers absolutely love the product? Defer the investment until that is true.
  1. Simple enough for your mother: Can your mother use the entrepreneur’s product or service? Simplicity is key for widespread adoption.
  1. Failure is a learning process: Past failures > No failures.
  1. Return time period: Expect returns no less than 5-7 years.
  1. Differentiate between the decision and outcome: Decisions must be taken using all information available to you at that time. You can’t predict the future and hindsight is always 20/20. A bad outcome does not necessarily mean a bad decision and vice versa. Don’t beat yourself up too much over a bad outcome, and then again don’t let a good outcome go to your head.

Good luck! And as always, if you do discover the next Google or Facebook, do let me know! 😉

With that said, here is the obligatory legal disclaimer that goes with any investment advice – Please invest at your own risk! 

The thing with VCs and early investors

The thing with VCs and early stage investors is: they are gambling!

It is just the way their business model works. Venture Capital is a ‘hits’ based business. Investors will typically invest in about 100 startups, out of which upto 75 of them will return very little or no money and 95 of them will miss their targets – in other words – 95% of them fail. The 2-3 that do succeed will return several orders of magnitude of the initial investment, which basically pays for the entire portfolio.

At the angel stage, the odds are even worse, where funds like 500 Startups, Kima Ventures etc. need to resort to a model of ‘Spray and Pray‘ – which basically means ‘spray money on a bunch of startups, and pray a couple of them succeed.’

What does this mean for the entrepreneur?

If you are one of the companies that has been ‘sprayed’ money on, what does that tell you of your investor’s belief in how well you will do? – Not much!

This applies even to top, highly selective funds like Y Combinator, which has graduated about 1000 startups (“The total value of the companies we’ve funded is around 10 billion, give or take a few. But just two companies, Dropbox and Airbnb, account for about three quarters of it.” – Paul Graham)

For the entrepreneur – the process of getting the investment really does NOT mean anything! It is just an extension of your life-line. If you have traction, then traditional VC investing metrics like strong teams, great products etc. become irrelevant in comparison. So, my belief is don’t focus too much on what Angels or VCs want but rather focus on what your users/customers want – you need to focus on building a viable business that solves a real problem – and less so on building something that investors would like to invest in or something where the VC community is ‘hot’ in.