Angel Investing: When is the right time?

The new and popular Angel Investing series continues with this question from a reader:

Is it advisable to wait until a company has revenue/profits before investing?

There is no secret formula as to when is the right time to invest in an early stage company. Typically, the earlier into a company you get, the greater risk you bear. While you may benefit from an attractive valuation or more formative influence on the company's direction, you have a long list of risks.

If your buddy's new startup brewing company has not produced its first batch of beer, chosen a name, secured a site to produce its product, or determined where to position itself in the competitive market, then your money is carrying the risks of any of those things not happening. So it is usually "safer" to invest in a company with revenue paying customers, a protoype or beta-version of its product. My feeling is that the more traction the company has the better you know what you are investing in.

The obvious trade-off is that the more milestones that a company has reached, the higher its valuation is likely to be. At the stage of an angel investment, valuation should not really matter too much. If you invest as an angel into a winner then it won't matter too much if you are in at 5 or 10 mm. What matters more is that it is a winner. If your plan is to nickel and dime your way getting a good return, you won't do well. The key is to get into a winning deal with reasonable valuation versus a losing deal with low valuation. Remember the goal is a liquidity event.

Intuitively it may seem that the farther along a company is, the more likely you will determine its chances of success. However, there is a paradox regarding a company's maturity. Meaning that when the company's future is further defined, the realm of possible paths it could take begin to become more limited. So basically, while your company becomes mature, the many possibilities of its direction become more narrow. This is just something to think about. Entrepreneur's might take advantage of the "endless possibilities" of their company, while investors who wait until a company has traction will better be able to know where it will likely end up.

Comments

[G.A.]

It's a great idea to weigh the risks and rewards inherent in investing early and investing later. As far as other timing goes, most would argue it has a lot to do with the economy. One big name in angel investing, Bill Payne, did a podcast interview on the ins and outs of angel investing for fundinguniverse.com/podcasts. He talks about the nuances of the industry and investment analysis.