I have been asked by many readers about the topic of angel investing. In looking at the most popular postings on this blog, my previous post about angel investing is one of the top two hits. So I am starting a new series called “Angel Investing” based on the questions and feedback of my readers. I am going to try a new format in this series where in each post I start by posing a few questions readers have sent me. If you have a question that you would like discussed in this series, shoot me an email. So here are two questions I have received:
For someone who is neither an expert in a particular field nor a full-time investor, does angel investing make sense?
How much diversification is good? Is it better to invest a smaller amount into a few deals, have much less influence over the company, but less money at risk in each deal, or a larger amount into a single company and be in a stronger position of control/influence (e.g. potentially even holding a majority share)?
These are all great questions and not easy to answer. Let me first say that I don't give financial advice and that private investments usually require that investors be accredited by net worth or certain threshold income levels. With that being said, if you are reading this blog then I assume you either have money, want money, or want to learn about how private equity works. You probably have some disposable income or have some money saved up. Maybe your good buddy is starting a beer company or your kid is starting a web business or you yourself are in a starup. So your friend's friend is starting a company that you think has potential and you are thinking that private equity seems appealing because of the return potential as well as the chance to be involved in a new and growing enterprise. So why not take the plunge?
Well, first and foremost, angel investing and private equity is not for the weary. You must either have so much money that you don't care if you lose it, or you must be the type of person that embraces risk rather than avoids it. If you invest into private assets, you are going to face the greatest risk of all - going illiquid, perhaps permanently. So with that in mind, if you are going illiquid my view is that you either want to go down in flames by trying to hit a giant homerun, or you want to grind it out by using whatever advantage you can, trying to hit singles and doubles consistently. The thing you need to remember is that there are lots of variables that are required for a company to succeed. Some of these variables are controllable, but most of them are not. In some sense, the "planets must align" for success and ultimately a liquidity event.
One of the best ways to increase your chances of success as an angel is to improve the controllable variables, by using your field of expertise. If you don't have an area of expertise then another method is to pick areas that you think are very high growth and to invest in that area only. In some sense by staying focused you will gain expertise in that area for each deal you do.
The issue of whether or not you are a full time investor and whether you need to diversify really hits the nail on the head about the key feature of angel investing - the ability to exert control and influence on your investment. The excitement and fun in angel investing is being able to influence and control the outcome of your investment by helping the company or being involved in its activity. Most successful angels enjoy working with entrepreneurs and companies. Most successful angels bring more than money to the table.
Now if you are too busy and want to take a passive role, then you are probably better off investing in a fund or joining an angel investing group that syndicates deals. I believe that even a full time angel will have a hard time performing better than VCs with huge bankrolls and connections. So if you are doing it part time, then you can't expect to perform better with passive angel investments.
I feel that it is better to exert control in fewer investments than to use the machine-gun approach for passive investments. I tend to categorize my previous angel investments as "active" or "passive", and these classifications tend to correlate with the amount of money I have in the deal. The more "skin" I have in the game, the more control I want to look over my investment. So I believe that diversification is good if you have a lot of "passive" deals but that concentrated positions are good for "active" deals.
One point I also want to make is that like all other types of private equity, access to the best deals is key. The biggest angel deal that I could not get into was an early salesforce.com round. I indicated my interest very early on for a 500k stake but ultimately was pushed out by some other very high profile angels who were very tight with the CEO. So like I said, it is difficult to get into the best deals early.
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