Is there a way to be successful as an investor in startup companies? We believe there is, but it requires a bit of hard work, enough investments to be well-diversified and some patience. We also think that it is most effectively done as part of a group.
Investing in startup companies (also known as “angel investing”) involves investing in early stage companies that have not yet reached the stage where traditional venture capitalists are attracted to the company.
Typically these early-stage companies may have a prototype or a few customers, but do not have enough sales for a venture capitalist to make an investment. It may be a couple of bright women or men who have a solution to a real problem that lots of people or businesses have. They believe lots of people will pay money for their solution and they have found a way to provide the solution at a profit.
As an angel investor you are making a high-risk investment into a company that is at a precarious point in their development. The company could either sky-rocket or crash and burn. How do you know for sure which way it will go? There are some things you can do in angel investing that historically have improved the performance of angel investments. Here are some things that angel investors have learned along the way.
Build a Portfolio
Angel investing can be profitable, but any single investment of this type has a high probability of failing to produce positive returns. In a 2007 study published by Robert Wiltbank, Ph.D. and Warren Boeker, Ph.D., (Access Full Study Here), the authors found the average return of angel investments in the study was 2.6 times the investment over a 3 ½ year period which equates to an IRR of approximately 27%. They also found that 52% of all exits in the study were at a loss.
How can the average return be so high when more than half the investments lost money?
The results are not dispersed across a standard distribution. The top 10% of exits accounted for 75% of the total returns in the sample and the top 7% of the exits achieved returns of more than 10X.
In round numbers you could say 5-in-10 investments were losers, 4-in-10 investments were about breakeven as a group, and 1-in-10 was a grand slam.
While 52% of the individual exits resulted in a loss, the results were more promising when considering the performance of the investor’s portfolio. Simply by building a portfolio of multiple investments, the angel investor could expect to see positive overall results more than 61% of the time. Investing in 10 companies is the minimum goal for diversification while investing in 15 substantially reduces risk and 25 minimizes risk.
The study showed that higher levels of positive returns were generated the longer an investor held their investment. Exits that lost money (less than a 1X return) were held for an average of three or fewer years. Exits that saw 30X+ returns were held for an average of six or more years.
Do Your Homework
Due diligence is the investigative process of validating the claims and assumptions related to an entrepreneurial investment.
The Wiltbank study found that that the median time spent on due diligence prior to investing was twenty hours. Sixty-five percent of the investments with less than 20 hours of due diligence exited at a loss. Investments with more than 40 hours of due diligence resulted in a 7.1X multiple on their exit.
Of course, it is not just the time spent, but the process used that produces results. Meeting and having candid conversations with the executive team can be critical in assessing the potential of a firm. Connecting with customers and suppliers and independently confirming data can be an invaluable means of validating assumptions and claims.
Know the Industry and Actively Participate
As an angel investor, your goal is for the company to grow and maximize its opportunity as quickly as possible. Prior to making the investment, industry experience can help validate if the company offers a unique value proposition, if their position is defensible, if barriers to entry and growth have been addressed and if the exit strategy is probable.
As an investor your value and contributions are in the form of mentoring, coaching, financial monitoring, making connections and promoting the company. Your involvement helping entrepreneurs to avoid mistakes you may have made in the past or helping them to imitate your previous successes can be invaluable to the success of a young company.
The Wiltbank study found that investment multiples were twice as high for investments in ventures connected to investors’ industry expertise. Furthermore, angel investors who interacted with the company several times a month versus a couple times a year experienced an overall return multiple of 3.7X compared to 1.3X respectively.
A Team Approach
Angel investing is probably best done as a group. You can go it alone, but it is unlikely that any individual investor would have industry experience, time and resources for due diligence and ongoing involvement required to ensure a high performing portfolio. In addition, a group of investors who are asking questions is more likely to find out any significant warning signs which might help avoid poor investments.
Atlanta Technology Angels takes a team approach to angel investing. Our members benefit through our vetting process where a team of analysts and ATA members screens many entrepreneurial firms monthly. Members can participate and lead a thorough due diligence process which leverages the industry expertise and professional network of our membership. As a member of the Angel Capital Association, we can also leverage a network of angel groups to identify leads, syndication deals, and best practices.
Atlanta Technology Angels, a non-profit association founded in 1998, is celebrating 20 years of collaboration among independent accredited investors in the Metro Atlanta community.
1. Angel Investor Performance Project - Returns of Angels in Groups. Robert Wiltbank, Willamette University, and Warren Boeker, University of Washington, 2007. Survey of over 500 angel investors in 86 groups and reports on actual returns on 1,137 exits. The report was published by the Kauffman Foundation.
2. The term Accredited Investor is defined by the US Securities and Exchange Commission in Rule 502 of Regulation D. Additional information may be found at