Like amateur traders in the stock market (expecting to win big on the next unicorn), nascent investors often imagine that angel investing will be their lottery ticket to wealth.
Some data backs up the hope, including a widely cited study (backed by the Ewing Marion Kauffman Foundation) showing that the average financial return for angel investors was 2.6 times their investment after three and a half years.
But that popular study was published in 2007, before the recession and before the technology sector hit its second boom-and-bust cycle. Today, the angel investing landscape has morphed dramatically from what it once was.
“I feel like everywhere I turn, I meet someone who’s decided to be an angel investor,” said Eric Gasser, an angel investor in San Diego and partner at angel group SEED San Diego. “Before the housing crash, you’d get into a cab and the cab driver would tell you he owned three properties. That was the red flag that something was off.”
Today, Gasser said, you get in the cab and the cab driver is dabbling in angel investing.
Experienced angels will open any conversation with a soliloquy on how neophyte investors misunderstand the risk associated with startups. And the problem is getting worse.
Earning Their Wings
To those still a little fuzzy on the definition of an angel investor, angels invest in small startups or entrepreneurs. They are normally the people who fuel “seed” rounds, the capital raised at the earliest stage of a new venture. These are the men and women funding rough ideas rather than concrete businesses with concrete plans. Because they fund at such an early stage, they take on much more risk than other investors.
According to the U.S. Bureau of Labor Statistics, about half of new ventures fail in their first four years. That means angels, who invest in these infant companies, take on a lot of failures.
Since the 1930s, angels have been required to meet the Securities and Exchange Commission’s standards for accredited investors, meaning they must have a net worth of at least $1 million and annual income of $200,000.
But new policy has loosened the rules around angel investing, letting more amateurs have a seat at the table. Today, it is not unusual to meet a casual angel investor or an amateur just learning the ropes.
Angels already had a reputation as being the dilettantes of the investor world: a community of retired executives looking for a place to put their extra cash.
“Angel investing is sometimes perceived as handshake-and-backslapping deals made in smoky rooms,” said Ashok Kamal, executive director of San Diego’s angel network Tech Coast Angels.
Add in a new flood of amateurs, and the community becomes even more amorphous.
But strategic angel investors exist, and they manage to make their money work full time — both for themselves and for their portfolio companies.
How do strategic angel
investors pull off the gamble
of investing in startups?
The San Diego Business Journal interviewed three local angels with reputations for taking their roles seriously, and picked the top tips and strategies from each.
Keep in mind that all three of these angels had similar approaches to investing, so we left out duplicate tips.
Eric Gasser
SEED San Diego
5 years’ experience in Angel Investing
7 total exits
Notable exits by portfolio companies:
Authy was acquired by Twilio in 2015
Lift Labs was acquired by Google in 2014
TIMING IS EVERYTHING: Gasser says that market timing is the number one indicator of a startup’s success or failure. “I’ve seen colleagues invest too early in great ideas,” Gasser said. “They were investing in ideas that were decades ahead of mass adoption, but they were only raising enough money to last them a few months.” These startups run out of cash and sputter out, Gasser said, making a poor investment for angels.
INVEST IN WHAT YOU KNOW: “I see angel investors who don’t spend enough time understanding how a problem is currently being solved,” Gasser said. “That’s where they get in trouble. They don’t fully digest the bigger picture.”
BET ON THE FOUNDER, NOT JUST THE IDEA: “As time goes on, everything changes but the founder,” Gasser said. “The product evolves, the customer experience evolves, the targets might shift, but the one thing that holds true is the founder. When times get tough, you want to know that the founder is going to think differently and that they’ll continue trying to solve the problem they’ve set out to solve.
BALANCE YOUR PORTFOLIO: Gasser said it’s important to balance your risk by investing in a variety of companies pursuing different verticals or markets. In other words, don’t invest in two companies looking to disrupt the same industry or solve the same problem. “A lot of angel investors don’t think this way,” Gasser said. “They don’t have a portfolio approach; they have a mathematical approach. They think investing in 12 companies means they’re balancing their risk.” Don’t just spread risk across multiple investments. Instead, spread risk across the problem areas these startups are looking to address.
Allison Long Pettine
SEED San Diego & Crescent Ridge Partners
11 years’ experience in Venture Capital
2 years’ experience in Angel Investing
Promising portfolio companies:
Portfolium, Lymber, Edico Genome,
Clarify Medical
LEVERAGE ENTREPRENEURIAL EXPERIENCE: A lot of angels are high-net-worth individuals who haven’t been in an entrepreneur’s shoes. Long Pettine said having entrepreneurial experience as an angel is key to recognizing good investments. “Having been through it (and come out of it alive) allows you to understand what the founder is going through, and also offer a perspective on how to approach problems they face when just getting started,” Long Pettine said.
BE IN IT FOR THE LONG GAME: “No early-stage investor should think every single company will be a success,” Long Pettine said. “When companies do have a good exit, it takes a long time to get there. It takes years for these companies to figure it out.”
TAKE EMOTIONS OUT OF FAILURE: Not all investments work out. Failure happens for a number of reasons, including bad management, poor timing or poor product execution. When you make a bad move as an investor, let go of the negative emotions and focus on learning from failure. “When an investment goes south, instead of just writing it off as a statistic, you have to think critically about what happened,” Long Pettine said. “Was there something you missed (or overlooked) in due diligence? Was there a fatal mistake the management team made that you can ensure no other founders you invest in will make again? Mistakes are much more valuable than the successes.”
DON’T IGNORE YOUR INTUITION: Investing is a lot about intuition. This tip is something that all angel investors interviewed for this piece agreed on. Intuition and “gut reactions” are often cues the brain gives when recognizing risky patterns or behaviors. Don’t ignore your intuition — cultivate it. “Hone in on that,” Long Pettine said. “Even if you think it’s a soft skill, it’s not.”
Sergio Gurrieri
Tech Coast Angels
5 years’ experience in Angel Investing
Led 6 life science deals
Notable investments:
Investor of Austin, Texas-based Savara Pharmaceuticals, which acquired San Diego public company Mast Therapeutics in January
DO YOUR HOMEWORK: “When I joined Tech Coast Angels, I wanted to apply the same rigorous due diligence of the venture capital model to angel investing,” Gurrieri said. “You need to be willing to do your homework.” That means identifying your personal investment rules, and adhering to them. “Most investors make decisions based on very little interaction with a startup company,” Gurrieri said. “There’s a direct correlation to the number of hours that you spend doing due diligence and the return on investment that you can expect. You need to be willing to spend the time it takes to gather a sufficient amount of information to make a wise decision.”
AVOID FIRST-TIME ENTREPRENEURS: “I’m sorry, but I don’t want to pay for your training,” Gurrieri said. “I’m not saying I wouldn’t make an exception, but you need to have ground rules as an investor. First-time entrepreneurs make a lot of mistakes. Not because they lack energy or passion, but because they don’t know what they don’t know.”
EMBRACE THE GAMBLE: “People often compare angel investing to gambling,” Gurrieri said. “In the beginning, I would fight this definition. But I evolved and I started saying, ‘Yes, it is a lot like gambling.’ But as an angel investor, you’re not the individual gambler — you’re the house. In order to win, you need to have enough diversification in your portfolio to be the house, and play often enough so that you can win the game.”
