Investors should expect to hear more about angel investing as the recently passed Jumpstart Our Business Startups (JOBS) Act reduces many obstacles that entrepreneurs face when seeking startup capital. Before you offer your highly sought reserves to one of these high-risk ventures, you should determine if you’re a good fit to become an angel investor.
Working with startups is thrilling. I sit on a review panel for a business-plan competition benefiting local startups in Richmond, Va. These visionary risk-takers invest immense amounts of creative energy, personal capital and sweat-equity in companies with unknown futures. Listening to them and sharing in this high-wire energy always inspires me.
Many entrepreneurs, unable to secure bank loans for new and unproven ventures and after exhausting the interest of close friends and family, turn to angels. Some of these angel investments do very well. The angel investor who wrote the first check to Google’s founders saw a $1 billion return. But for every success, many angel investments sank from sight with businesses that never made it.
Before you open your checkbook to a high-risk new venture, consider the following qualities of successful angel investors.
Identify and Align With Experts
Recently, angel investing has organized. You are more likely to find success if you align yourself with others with angel investing know-how and you no longer need to move to Silicon Valley to find such experience. Most metropolitan areas have angel networks made up of somewhere between 10 to 200 wealthy individuals who find social value and economies of scale by working as a collective. And these groups are often looking for new members.
Angel investors often organize syndicate deals, joining together to invest with a lead investor who negotiates the terms with the startup. The best investments get funded quickly and you’re more likely to be on the early side of this so called deal-flow if you network with other angels with a strong reputations for providing funding.
Successful angels pass on hundreds of investment opportunities for each worthy candidate they find worthy of investment. Any one venture faces low odds of success so diversify your portfolio to spread the risk, just as in smart stock market investing. Matt Rho, who is part of a firm that invests $1 to 5 million per year in small and mid-sized startups, suggests that $500,000 is a minimum in financial commitment to get started in a serious way. His model: five $20,000 investments per year over five years, for a portfolio of 25 startups.
The likelihood of any one company returning a large gain to angel investors is low and expectations for large portfolio returns are hard to come by. The self-reported results of angel investors from the often cited Returns to Angel Investors in Groups (paid for by two foundations supportive of Angel investing) cited a loss of money in 52% of the cases studied. Even when your investments do well your capital is often out of reach, as angel investments are illiquid and typically require a five year holding period or more.
To protect investors, the Securities and Exchange Commission (SEC) requires that most investors in these startups be so called accredited investors, meeting one of the following conditions:
1. Net worth, not counting your primary residence, of $1 million;
2. Individual income of at least $200,000 in each of the last two years and a reasonable expectation for this to continue;
3. Joint income with a spouse of $300,000 in each of the last two years and a reasonable expectation for this to continue;
These SEC investor qualifications make a crude and potentially dangerous litmus test of your financial capacity to withstand losses in angel investing. A more customized approach begins by checking to see if you’re on track to meet your retirement goals. If your current and projected savings exceed what you require for the rest of your life, you have excess to angel invest.
Business Insight and Influence
The best angels also lend experience and influence to entrepreneurs and become business boosters. Retired entrepreneurs can make some of the best angel investors for new companies emerging in their field of expertise. Maybe a young entrepreneur just needs am introduction to an essential customer or advice to cut through the red tape of government contracts. For these angels, investing is a partnership.
As you consider angel investing, try to answer this question, “what type of insight, experience, or connections can I lend to a startup?”
Intuitive Decision Maker
Rho also points out that the best type of angel investor is one who is decisive. “A quick yes or no. And if yes, comes through with a check. The WORST kind of investor is one who drags people out.” Busy entrepreneurs are acting as the president, HR department, compliance, analyst and accountant all in one. The last thing they need is a pestering potential investor who monopolizes their limited time.
Paul Graham, a famous Angel investor emphasizes this point when he shares, “Don’t get hung up on mechanics or deal terms. What you should spend your time thinking about is whether it’s a good company.”
Those who stick with angel investing appreciate factors not found on business financial reports. They appreciate connecting with entrepreneurs and becoming, with each investment, a partner in the hopes and dreams of real people.