Updated: Mar 28
In order to set good investment targets we need to consider your personal motivation for investing in startups at early stage.
Personal Motivation for Angel Investing
People have widely varying reasons for being an Angel, and it is vital to know your own. This personal-value-based approach will drive all your other investment decisions. Is it primarily about the money? working with interesting people and companies? making a contribution? socializing with other Angels? buying a job for yourself?
There have been many academic studies of Angels’ motivations over the years (Morrissette). Sullivan & Miller were the first to show that a large number of Angels were willing to accept lower returns by essentially exchanging non-economic psychic or social rewards for financial ones. They classified them into three major types, depending on their primary motivation:
47% of Angels are economic investors who primarily want to maximize monetary wealth:
• ROI is the most important
• Highest ROI expectation (30% ROI expected vs only 21% ROI for non-economic investors)
• Largest average investment size
31% of Angels also seek non-economic or psychic rewards:
• Enjoy investing, like the entrepreneurial process and the fun of being involved in an exciting company. Enjoy the thrill of the ride!
• Lowest ROI expectation (21% expected vs 30% for economic investor)
• More likely to invest with a group
• Skew slightly older
22% of Angels also have altruistic motivations and want to help entrepreneurs and/or society; sometimes called “pay-it-forward” reasons for investing:
• See the value in supporting new business and/or socially beneficial products
• Most patient investor, willing to hold for seven years or more
• Smallest average investment size
Mary Long-Irwin of Northern Ontario Angels agrees with the importance of this motivation: “We live in smaller communities and we know each other and want to make sure the companies are successful. The investors care about the economic growth
of their communities. It’s about creating jobs and wealth where they live.”
There are as many motivations for Angel investing as there are Angels. Understanding your own motivation or style will help you make better decisions and help you select better co-investment partners. Co-investing with someone is a long-term commitment, and you should know each other’s expectations before working together.
What Kind of Angel Are You?
Let's start by understanding what kind of angel investor you are.
Several writers have provided extensive descriptions of Angels (e.g., Gaston; Hill & Power; and Benjamin & Margulis). Do any of these describe you?
Archangel or Super Angel: Wealthy, powerful, experienced Angel who has done a lot of deals
Guardian Angel: Provides mentorship, advice and life coaching
Cherub: A neophyte Angel, usually following other Angels to learn the ropes
Angel-Knows-Best: Becomes bossy, arrogant or overbearing
Corporate Angel: Often a corporate venture capital investor disguised as small or nice
Will-Work-for-Equity Angel: Wants to barter services for a share of ownership (often not an Angel)
Unaccredited Angel: An oxymoron (like jumbo shrimp)
Dragon (aka Lion or Shark): Celebrity Angel who does deals on TV, often using extreme behavior
Daddy Warbucks: Very wealthy Angel, often investing without extensive due diligence
Dark Angel: Wants to kick out the founders and take over the company
Fallen Angel: Lost reputation through bad behaviour, loss of wealth or liquidity issues
Consultant: Not an Angel at all, looking to be hired to do accounting, legal or other services
The Godfather: An Angel with an air of being well-connected and knowing everyone, usually retired
Peer: A fellow successful entrepreneur Angel (includes one-third of all Angels)
Dr. Kildare: An Angel who is a doctor, lawyer, accountant or other professional passively investing small amounts
Business Devil: An Angel who wants absolute control, insists on 51% or restrictive covenants
High-Tech Angel: Invests only in high-tech
Lead Dog: Rounds up other Angels to co-invest or syndicate deals
Lone Wolf: An Angel investing on his or her own
Silver Spoon with Silver Wings: An Angel with second-generation money, born wealthy and well-connected
Cousin Randy: A relative who invests small amounts and often wants to work inside the company
Chorus of Angels: Collective noun for a group of Angel investors, also called a consortium or syndicate
Personal Capital Budget Available to Invest
This amount should be selected in consultation with your financial advisor, spouse and heirs. The general opinion, especially for economic investors, is that no more than 10–15% of your total investment portfolio should be available for Angel investing.
Another approach would be to first ensure that all your family needs are satisfied with secure investments, and then make the remainder available for Angel investing. (Example: Once you have set aside, say, $20 million to fill all your needs, it doesn’t matter if your Angel investments are $2 million or $50 million.)
In reality, only half of all Angels actually invest less than 15% of their total net worth. A study by Freear, et al., found that 19% of their sampling of Angels invest between 25% and 50% of their total net worth in Angel investments.
You should account for the fact that Angels usually need to hold on to their investments for three to eight years. Some Angels in certain sectors hold for even longer periods.
For example, Jim Estill, a Super Angel from Waterloo, found that his 150-plus investments had an average hold of 14 years prior to exit. These investments are very non-liquid. You need to ensure that you retain sufficient personal liquid capital assets in case of emergencies.
If you have annual personal income, you should also estimate how your capital budget might change with time. For example, you might start by setting aside $200,000 but then add $50,000 per year so your portfolio target budget is $500,000 over six years.
Don’t allow yourself to get caught up in the excitement of the deal and don’t allow the amount you invest to be unduly influenced by how much money other people are investing in a deal. Set your limits and stick to them!
The next major decision is how to spread your personal capital budget among investee companies. We know that most Angels make 90% of their returns from 10% of their companies. So investing in only one or two companies is almost certain to lose money. Risk management theory tells us that the more companies you invest in, the lower the variability in your returns. The most common advice here for good risk management is that you should seek to hold at least 20 companies in your portfolio or augment a smaller number of direct investments by investing in an Angel fund or Angel sidecar fund.
A Real Options Approach to Angel Investing
Unlike traditional investing, Angels should have a different approach to portfolio investing, because the distribution of returns is not a standard distribution, but one in which more than 50% of investments fail – producing zero returns. The idea is that Angels invest small amounts in a number of ventures, with the idea that some will fail fast, while others will show progress, at which stage additional funds will likely be required (often from the original Angels). This is called a Real Options approach and has three fundamental consequences:
1. Investments of smaller amounts are made, with early milestones agreed, which if reached trigger subsequent rounds of funding.
2. The Real Options approach encourages Angels to look for investments that can be rapidly validated and either fail fast or show rapid progress (however small).
3. The number of investments made is larger, because the Angel does not have to keep as much money in reserve for follow-on investing, as they will not have to invest subsequent funds in the companies that fail.
— Dr. Andrew Maxwell, Chief Innovation Officer, Canadian Innovation Centre
To further diversify risk, you could consider whether you want to diversify by sector,
or focus your attention on certain industry sectors in which you have a personal interest or expertise, or that you think are hot. Most Angels focus on certain sectors but might co-invest outside that sector only with highly trusted partners. Diversifying the business development stage, geographic location and number of co-investors is another way
to manage portfolio risk. The simplest way to enhance your diversification is to invest in an Angel fund or Angel sidecar fund (we'll explain this later).
Virtually all professional investors – not just Angels – will also tell us that, in addition to the initial round of funding, you should reserve up to an equal amount of money for any potential follow-on rounds of financing. This reserve is referred to as keeping your powder dry.
There are several reasons for needing dry powder. You will be able to negotiate a better deal, and suffer less dilution in any subsequent investment rounds, if you are co-investing on the same terms as your new investors. The vast majority of entrepreneurs, and Angels, underestimate the amount of money they will need. If a company unexpectedly runs short of money, the very last thing you want is to try to raise the next round of financing when the company is in distress.
If you have $2 million to invest, you should consider investing half that amount in
20 companies, or around $50,000 per investment on average. If you estimate that you will hold each company for five years, it means doing at least four deals per year.
On the Other Hand...
This doesn’t feel practical to me. While it is good advice and mathematically sound, an Angel with $2 million ready to invest will not likely have the discipline to pace the initial $1 million over five years. It is more likely that once they get exposed to decent deal flow, two things will happen:
1. They’ll start seeing very good opportunities and they will seduce themselves into more than four deals – if not in the first year, then almost certainly in the second.
2. Similarly, they will want to invest more than $50,000. This is especially true early in their Angel life when they have more powder available to invest. If opportunities are good and Angels convince themselves that they can do $50,000, the threshold to convince themselves to go to $75,000 or $100,000 is lower than the first $50,000.
This is why many Angels get tapped out before exits start replenishing the keg.
It’s difficult for Angels to have the discipline to stay within targets (if they have them). That’s because once they’ve convinced themselves a deal is good, and that (for the immediate moment) it’s the best deal around, it’s natural to wonder, if it’s good for $25,000–50,000, why not $75,000–100,000?
Other influences that come into play when deciding on the amount to invest:
• Interpersonal “chemistry” with the founder/team
• All that’s left before closing the deal is a small amount
• The Angel’s experience/knowledge of the industry
• The nature of the product and market opportunity
• The co-investors
• Intellectual property
• The concept is in a race to market
• Being flush with cash (e.g., partial or full exit just happened, bonus was just paid)
— Frank Erschen, Charter Member, Golden Triangle Angelnet
The major portfolio target variables are:
• Percentage of total net assets (or total amount of Angel capital available)
• Number of investments (if less than 10, consider including an Angel fund)
• Percentage of cash in reserve (dry powder)
• Average amount per investment
Portfolio targets may also include preferred types of deals, such as industry sector, stage and location.
Very Conservative Angel Portfolio:
$25,000 per investment x 2.0 (a powder reserve of 100%) x 15 investments = 10% of net worth Net worth required = $7,500,000
Conservative Angel Portfolio:
$25,000 per investment x 1.50 (a powder reserve of 50%) x 12 investments = 15% of net worth Net worth required = $3,000,000
Less Conservative Angel Portfolio:
$25,000 per investment x 1.35 (a powder reserve of 35%) x 6 investments = 25% of net worth Net worth required = $1,000,000
— Bill Payne, in Asset Allocation and Portfolio Strategy for Angel Investors
Most of the Angels I have spoken with agree with Frank Erschen and frequently deviate from their portfolio targets. Many of them invest more money in fewer deals and keep less of their powder dry. In some cases, they augment this smaller number of deals and hit their portfolio diversification goals by also investing in an Angel sidecar fund or Angel group fund to reduce risk.
Mike Cegelski, on Angel portfolio targets: “I invest around 20% of my net worth –
I know that’s considered a lot, but it’s something I know and feel comfortable with.
I maintain a portfolio of more than 20 companies and try to keep it under 30. I’m early- stage but not too early – I like to see revenues. I keep 50% for powder and I like to follow-on invest when needed. I prefer “one-and-done” investments and earlier exits. I’m not seeking unicorns. I’m happy with 2–5X returns instead of 20–30X deals that need a lot of money. I’ll invest $100,000–150,000 and potentially another $300,000– 500,000 in a follow-on round per company.”
Value Investing vs Momentum Investing
Angels should consider whether they are going to take their time to look for long-term value or try to catch a wave with momentum investing to get in on a hot deal.
In Startup Wealth: How the Best Angel Investors Make Money in Startups, Josh Maher classifies Angels into three different types of investor: value investor, momentum investor and alternative investor. In some cases, quotes from different types are so at-odds with each other that one can hardly believe each can be classified as an Angel.
When hearing conflicting advice from successful Angels, consider that they might be speaking from different camps.
“One of the biggest dichotomies right now is there’s this rift between this somewhat consumer-led, consumer-mobile kind of deal flow that is prevalent in Silicon Valley [momentum investors] and the rest of the world [value investors]… [Momentum deals] are like popularity contests and it’s all about moving fast… [Value investors] are trying to find great teams and great opportunities at good companies – need-to-have products, rather than nice-to-have products… and then – and this is crucially important – help the companies afterward” (Christopher Miribile, in Maher).
The momentum approach recognizes that at times there is competition for the best deals, and the meta-trend is that it is becoming easier and easier to find smart money.
So the best entrepreneurs may have lots of choices and get the most money from the best investors. The only way to get in on these great deals is by being better- connected, writing cheques faster, and/or offering better deal terms.
Some Angels view each deal independently and assess whether the deal itself requires a momentum, value or alternative approach.
Co-Investing With Other Angels and Angel Groups
There can be a lot of work in Angel investing. It would be virtually impossible to meet personally with 200 companies, complete due diligence on 30, paper 20 deals, and then sit on 20 boards of directors. Unless this is their full-time investment management organization with staff, most Angels specialize in chosen aspects of the process
where they can really add value and develop expertise. And unless you are a Lone Wolf doing everything yourself, you will be sharing the workload with other Angels or
Angel group managers.
To fit into this ecosystem, take some time to do an honest assessment of your interests, strengths and weaknesses. How active or passive do you want to be, and which aspects of Angel investing do you want to focus on? Are you really good at assessing the character, integrity and trustworthiness of other people? Or are you better at detail-oriented analysis of the pro forma financial projections? Do you want to play a lead role in the due diligence process and negotiate the deal? Do you want to sit on the board of directors or advisory board of the investee company?
Working as part of a consortium of Angels is a great way to learn, share what you know, mitigate risk, and really get to know and develop a trusting relationship with your co-investors. Many Angels tend to find several people that they like to do deals with, and this is part of the joy and excitement of Angel investing.
“I’m very pro co-investing. People with different ideas and knowledge prevent you from falling in love with a company. I particularly like to co-invest with an expert who can run the numbers – I’m not a finance guy. I like to focus on the entrepreneur. The people are really the key factor because the company will need to pivot. I rarely invest alone unless I’m doing it due to a personal connection. In those cases, it’s really love money, and I’m investing in a friends-and-family round.” (Mike Cegelski)
Angel groups like YarakSeed Ventures, provide many benefits to its members, including:
• Access to a regular deal flow of investment opportunities
• Pre-screened investment opportunities can save time
• Opportunities are presented in a consistent format
• Investment presentations by entrepreneurs are regularly scheduled
• Opportunities to network, co-invest, and make new friends with other Angels
• Share the workload of due diligence and deal negotiations
• Educational opportunities
• Access to an array of experienced consultants and advisors
Angel groups work in many different ways. In some cases, the group manager will find, select, complete due diligence and negotiate the deal, then present the deal to the members, who make their own independent yes/no investment decisions. Other groups, are run by volunteers who perform preliminary screening and organize events where the Angels meet prospective investee companies. Any Angels interested in potentially investing then meet separately in private to organize due diligence and negotiate a deal.
Some Angel groups, such as Angel One Investor Network and VANTEC, have formalized the role of lead investor as the primary point of contact with the entrepreneur. They follow a lead investor guidebook that clarifies the specific responsibilities of this critically important person who not only leads the negotiations with the entrepreneur, but also is the primary contact for all the Angels co-investing in the deal and any contractors involved (such as legal counsel).
Another example is provided by Frank Erschen regarding GTAN: “Since its formation in 2009, several Angels have stepped forward to take the lead role in deals. This evolved naturally. It soon became evident that the lead role was critical for coordinating multiple Angels, performing due diligence, and negotiating and closing the deal. It then became clear that the number of Angels who could, and would, take the lead role was the determining factor in getting deals done.
“GTAN continues to be very efficient at qualifying investees through their selection committee, but when investees pitched at GTAN’s monthly Angel meetings, if there wasn’t an Angel who could take the lead role, due diligence was slow or wasn’t initiated. In response, GTAN instituted an education program for Angels and encouraged more Angels to take lead roles. Deal leads also had the ability to call on more- experienced leads for help.”
The preferred level of involvement in the company varies tremendously from Angel to Angel and from deal to deal. Some Angels want to fill an operating role in the company or have weekly oversight of the company finances. Others are completely passive.
Many want to sit on the board of directors or an advisory board. Yet others want no direct involvement but are available to help as needed. It is important that the expected level of involvement be clearly conveyed to the entrepreneurs early in the process.
Level of Involvement Differs Among Angels
For many Angels, being involved in the company growth and exit is everything: “Anyone can write a cheque. The hard part is what happens after the investment is made.”
— Peter Kemball, CEO, The Kemball Group
Others are more reactive: “I give the CEO my phone number and expect a call whenever help is needed. I trust my entrepreneurs to be responsible executives who know when to call me. I can’t add any value by pestering them or asking them to send me reports.”
— Mike Cegelski, Angel Investor, Kouraje Management Inc.
Yet others are more formal in their processes: “All of our investee companies fill out mandatory quarterly reports using our prescribed format. These formal reporting duties are included in the term sheet and shareholder agreement.”
— Ross Finlay, Co-Founder & Director, First Angel Network
“Good luck actually getting the reports!”
— Mike Volker, Co-Founder, Vancouver Angel Technology Network
A liquidity event takes place when an investor gets cash back for the cash he or she put in – often with the investee company being acquired by a larger firm or perhaps going public. In some cases, a secondary investor may buy out the earlier investors. Or the entrepreneur may pay back the investors through royalties, dividends or share buy-backs.
An exit event includes all forms of company exits, including not only liquidity events, but also failure, bankruptcy or acquisition, when certain investors or creditors get zero return.
A “zombie” or “walking dead” company continues to exist and perhaps slowly grow, but the investor can neither get their money back nor write off the investment as a loss. The management team and staff may get well-paid, nice jobs, but the Angel gets nothing. These are sometimes called lifestyle companies because the founder has a nice lifestyle, but the investor does not get a return.
Eventually, Angels are interested in an exit event. Entrepreneurs and Angels can have very different opinions on when, how and for how much it will occur. Often, term sheets and shareholder agreements contain clauses that allow Angels to force an exit, even
if the entrepreneur disagrees. These terms can be highly contentious, so you need to know yourself well enough to know if you are prepared to be involved in the company to the extent required to force such an exit – otherwise why bother to negotiate for these clauses?
As noted by Dr. Andrew Maxwell: “All investments are made with the intent of achieving a good exit, but surprisingly limited attention is paid to potential exits when making the investment decision (Mason, Harrison & Botelho). This is particularly surprising, given what we know about different rates of return obtained by following different exit strategies (acquirers and timing).
“Given the adage, ‘start with the end in mind,’ it is critical that Angels recognize that the most common successful exit (more than 80% of cases) is being acquired by a company in a related business that can drive more value from the venture than the company can achieve on its own. This has significant impact on the way the early rounds of investment take place, the strategy of the business, and the initial term sheet. Even before attracting its first round of investment, a company should be able to identify potential acquirers and what strategies or tactics it might take to engage those companies.”
Mike Cegelski states: “I try to keep my post-investment level of involvement to a minimum. If you’re in there, it means they are having ‘issues’ and that’s a bad sign. I can’t really help 20–30 companies, so I’ve become an expert in delegation. I like to help with contacts and maybe sit on a board but I put my time and effort into making good deals.”
Personal Education Goals
Lifelong learning is an important element of health and wellness. Angel investing provides ample opportunity to stretch your intellectual muscles. There is much to learn about future trends, new technologies, new business models and new entrepreneurial tools. Staying on top of what is hot, and which companies are acquiring or merging with others, can be rewarding and pay off big dividends. Learning how to become a better mentor and coach can also benefit your personal life.
According to Frank Erschen: “When you decide to become an Angel investor, you are also committing to a new wave of learning. Unless you are a former entrepreneur, or worked at a venture capital firm, or come from a mergers and acquisitions background, you are entering a new world.”
YarakSeed Investors Academy provides an array of educational articles and resources that can help you improve your Angel investing practices.
Dr. Andrew Maxwell states: “Angels can learn a great deal about Angel investing – from each other, from research, and from Investors Academies – that can help them identify superior deals, make good investment decisions, and guide entrepreneurs to achieve better outcomes. More-experienced Angels invest differently from the less- experienced and generally achieve better outcomes, creating a motivation to find ways to share knowledge and experience, as well as deals.
“Angels with a knowledge of the basic aspects and terms of Angel investing will be better prepared for investing and will have more realistic expectations of investment outcomes. Angels who have a better understanding of their own motivations, strengths and weaknesses will be able to find promising opportunities where they can add the most value. Angels with a better understanding of both the investment decision process and the path to successful exits will be able to achieve a higher level of return on investment, while understanding how specific factors influence the likelihood of long-term success will improve the quality of their investment decisions.”
The following Angel self-evaluation tool allows you to mark an X on the line to better understand where you think you want to be, in general, between the two extremes. For example, do you want to be invisible or do you want to make it very easy for potential investees to contact you?
Angel Self-Evaluation Tool: Set Good Targets
Take a moment to think about the answers in each of these sections.
Personal Angel Portfolio Targets
Personal Education Goals:
a) Local Angel Events
b) National/Global Angel Events
c) YarakSeed Investors Academy
d) Other Startup Ecosystem Events
Source: Adapted from First Ed. NACO Angel Investing.
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