Many first angel investments are sad stories.

The rookie angel investing cautionary tale

After a significant liquidity event (e.g. the sale of a business), a new angel decides to make a substantial investment in a startup company which sounds promising. This investment will often be the only significant source of funds for the startup. When the company starts to struggle, the investor gets actively involved to “save” their investment. To rub salt into the wound, the angel goes all-in with a follow-on investment. It all ends in tears. The investor loses a lot of money, hates the entrepreneur and swears never to make another angel investment.

Lesson number one on becoming an angel investor is avoiding the rookie mistake. The first angel investment should be small.

Lesson number two is: angel investing takes some time to learn. The best way to learn is to join an angel group. This is why!

How do you make money when 90% of the time the investment will “fail”?

Angel investing is very risky. Half of all angel investments will fail outright. A further 40% will return somewhere between a portion of and two or three times the investment. Only 10% will genuinely succeed, and they need to cover the failures.

The answer is you need some understanding of angel math. Angel investing is a positive-sum probability game, where the wins need to more than offset the losses.

Positive-sum angel investing requires an extensive portfolio of suitable investments

In simple financial terms, angel investing is investing in companies with a 10% probability of making 25-30 times over a five year plus timeframe. On average, the game pays out 2.5 to 3 times the overall investment, equating to a 20 to 30% p.a. internal rate of return. So the game is worth playing.

To make the angel math work, an angel investor needs 20 to 25 investments to have a high probability of success. I will present an angel investing simulation model in future posts. The model highlights why so many investments are needed and why even more is better.

A critical observation is that the wins need to be at least 10 times the investment. A typical angel investment needs to have the potential to make 25 to 30 times the outlay to justify the risk. This required potential return restricts the types of deals an angel investor considers. It is impossible to make these types of returns without taking the risk, which is why the failure rate is so high.

Making 20 to 25 investments is easier said than done! There are three interrelated challenges.

Deciding on investments is the first challenge

Analysing startups is different to mature companies that have financial history. Startups have no financial history! It is easy to find reasons not to invest in a startup company. Remember, most angel investments will fail. But if an angel is too fussy about selecting investments, they will fall short on building a 20 to 25 company portfolio.

An angel needs to have an investment process that doesn’t pass on every investment.

While there is some “science,” angel investing is also an art, and it can take some time to assess startups. The quickest and easiest way to learn about angel deal selection is to join an angel group and learn from experienced angel investors.

Managing deal flow is the second challenge

The process of finding investible deals is a sales funnel that has multiple stages:

• access to deal flow
• screening
• pitching
• diligence, and
• closing

Each of these stages requires time and effort. An angel may need to screen 20 to 50 investments at the top of the funnel for every deal. Of these, the angel may see 5 to 10 pitches and do additional diligence on 2 to 3 companies to close on that one investment. To build a 20 to 25 company portfolio, an angel will need to screen hundreds or even thousands of deals. Managing the funnel takes lots of time and only becomes easier with some experience.

Establishing processes to source and manage deal flow is not straightforward. For example, if an angel actively advertises, plenty of entrepreneurs with bad ideas will approach them. The angel may need to screen more than 100 investments for every investment. On the other hand, if the angel doesn’t advertise, they may not get access to enough deal flow.

The easiest way to access, understand and manage deal flow is to join an angel group. They have established deal funnels and processes which allow new members to participate and learn.

Alternatively, an angel can invest via angel syndicates, where the syndicate manager looks after the deal flow and the investor only sees curated deals.

Investment cadence is the final challenge

Investors will typically have a predetermined total allocation for angel investments. To determine their per-deal investment amount, they will divide the total budget by the number of investments they wish to make.

It is impossible to make all these investments immediately. A typical angel investing cadence is a new investment every 1 to 3 months. In practice, it may take a few years to make 20 to25 investments.

But the flow of investible deals varies over time. It is often a case of feast or famine. Managing the deal flow funnel requires constant tuning. It is easy to fall off the necessary investment cadence. Without 20 to 25 investments, the angel math doesn’t work.

Angel groups have a regular flow of curated deals that make it easy to maintain cadence. Investing in the best deal at a monthly angel meeting is a simple, effective way to get started. Investing via angel syndicates is another way to manage the cadence challenge.

The difference between angel groups and syndicates is the level of active involvement

Angel groups and syndicates are both effective ways to build an angel portfolio. The main difference is angel investors are more involved with the entrepreneur in an angel group. Angel investors are often attracted to some of the non-financial reasons to become an angel investor.

The investing process in syndicates is mainly outsourced to the syndicate manager. The investor typically has little access to the entrepreneur by design and doesn’t see the deal funnel. The syndicate manager is paid fees for the service and has subtly different financial incentives to the investor.

Initially, the best way to learn is to spend some time as a member of an angel group. Angel groups teach the game, angel math, deal selection, managing deal flow and cadence. These are worthwhile skills to properly assess angel syndicate deals.

So, don’t make the rookie mistake and become a cautionary tale! Join an angel group and learn how to be a successful angel investor.

I will write in more detail about angel math, angel deal selection, managing deal flow and investing cadence in future posts.