Angel investing has taken off in our country. The broad success of the television show Shark Tank has contributed much to its visibility and participation. Once the exclusive financial playing field of the very highest of high rollers, it has become more mainstream. Here are some of the basics of how angel investing works. If you are considering opening up your checkbook to a stranger or enthusiastically pitching the future colossal success of a startup with little more than a slide deck, you should understand these principles.
How does angel investing work?
Angels invest their own money; venture capitalists invest other people’s money. Big difference legally as well as in your pocketbook. Simply put, the SEC says you need an annual income of $200,000 for the past two years or at least $1 million in net worth, excluding your home, to be an ‘accredited’ angel investor. That’s because it’s high risk…and a numbers game on top of that risk.
Let’s look at those numbers.
Angels invest small amounts of money in a large number of startups over time. Set a goal of 20-25 total company investments, at the very least. The greater the number of investments, the better your odds of one of them hitting it big. Realistically shoot to make 2 – 4 investments per year. While that sounds manageable, you’ll likely have to look at ten times that number, just to find those few. And you will likely do this for at least five years, but probably longer.
How much should you invest in each deal? Plan for each investment to consist of $10,000 – $25,000. And this does not include follow-on investments because startups always need more money. Pause here and do the math on the above. If you’re not prepared to earmark that much money, over that much time, perhaps your portfolio would be better off without this really, really risky component in the first place. The law of large numbers applies here.
How long does it take to see success or what we refer to as the home run?
The average holding period of an angel investment in a company is around 9 years. Nine! That means your money will be tied up in an illiquid investment for nearly a decade – if the company even makes it that long. By the way, 50 percent will not; another 20 percent will muddle along but go nowhere. Of the remaining 30 percent, you hope that one gives you the big ‘hit’ to make up for all the others.
Where do you find those two or three, maybe four startups worthy of your money, each year? The most expedient path to regular startup deal flow is through an angel group. I highly recommend joining one because the management finds the deals, performs some basic screening and invites the founders to “pitch” the group members at a monthly meeting. Feedback and opinions from like-minded angels in the room will also help you decide when it’s right for you to invest. More often than not, they’ll also help you to walk away.
The DMV has at least a dozen angel groups that meet regularly.
Their members are active check-writers. Some have been around for more than a decade; others are brand new. Most will invite outsiders to attend one meeting as a guest, so reach out to them. Many incubators hold annual pitch competitions of their cohorts; get on those lists to attend. And, many networking conferences that have gone virtual also feature startup companies pitching for investment. Sign up for those digital events. Most importantly, talk to some veteran angels before you decide to take the financial plunge – figuratively, that is. Learning how angel investing works is critical to your success as an investor and no better way to do that than by participating in our local angel ecosystem.
Finding the angel groups is easier than you think. For more information, check out our blog on how to find angel investors.
Liz Sara, Founder & CEO, Best Marketing LLC; angel investor; Chair, National Women’s Business Council