Angel investors dream of finding and investing early in the next Uber, Airbnb, Waze, or Mobileye. While it’s easy to get seduced by the hype, serial startup investors know it is hard to be successful in this asset class. With the help of members of OurCrowd’s experienced investment team and other industry resources, we have put together a quick, three-part guide to ‘earning your wings’. These articles highlight essential terms and strategies while referencing accepted industry best practices; with these basics in hand, getting started in startup investing can be a lot smoother.
Part III: Strategy
One of the most important rules of investing is diversification. The more companies you invest in, the greater chance there is at least one “winner” in your portfolio to give you the return you’re looking for. In angel investing, you could focus on diversifying based on company industry, and business stage. Some experts say that 10-15 companies is the minimum sweet spot for building a strong portfolio, while the Monte Carlo Simulation suggests that 25 investments provides the optimal return. Read more on the topic in our previous article, Risk and Reward: the Truth about Diversification.
Invest More than Money
Be a resource to the startups you invest in: their success is your success too. According to Dr. Robert Wiltbank and Dr. Warren Boeker’s study, angels who interact with their startups more than once a month saw multiples of 3.7X over four years, while those that only checked up on their startups a few times a year saw returns of 1.3X over 3.6 years. Angels Ashton Kutcher and Mark Cuban throw themselves behind their portfolio startups while still allowing room for the team to operate with independence. Angels should strive to offer their startups connections, business advice, and mentorship to help their investments succeed. OurCrowd’s Corporate Innovation Program are rooted in this investing philosophy.
Bet on the Jockey
Finding product-market-fit is a process. Very few founders get it right the first time, or the second time, or even the third. They are constantly challenging their beliefs, looking at data, taking risks, and iterating with their products. Do you trust the company’s founders to know when to pivot? This underscores the need to support the type of entrepreneurs that demonstrate grit, creativity, and an unbreakable spirit whereby success is the only option.
Slack and Flickr, for example, were both unsuccessful attempts by founder and CEO Stewart Butterfield to create a “never-ending” online game. Instead of trying to force the game on confused consumers, Butterfield took the features they developed to support the game and revamped them into not one, but two successful companies. To see examples of some of the most lucrative pivots, read Billion-Dollar Pivots: Key Lessons Behind 3 Incredible Success Stories.
Be a Contrarian
It’s critical to have and follow an investment thesis (even if it changes over time due to experience). Successful angel investors capture a lot of the risk and the reward from participating in the seed rounds of companies no one else believes in. Peter Thiel, co-founder of PayPal, Palantir Technologies and many other successful ventures, is the epitome of a contrarian. He was an early investor in Facebook, LinkedIn and Yelp, among other successful companies because he didn’t see the way the world was, but what it would be. “The reasonable man adapts himself to the world: the unreasonable man persists in trying to adapt the world to himself. Therefore, all progress depends on the unreasonable man.” His book, Zero to One, is a must read.
Risk vs. Reward vs. Expectations
While being a contrarian can be an exciting risk with dramatic return prospects, finding unicorns is rare. With this in mind, first understand your own risk limit, and manage your expectations accordingly. For example, if you think that investing in seed stage companies is beyond your comfort level, it might not be prudent to expect 100X multiples from companies raising their later-stage rounds. According to Industry Ventures, the best case scenario for later-stage company investment is a 3X return. Make sure that your return expectations match your risk-level.
That concludes Part 3 of the series; be sure to check out Part 1 and Part 2. You can also learn more about startup investing terms and how the process works by reading our in-depth guide, How Startups Are Born: An Investor’s Guide for the Perplexed.
Do you have any risk-taking stories of your own to share? Leave your questions and comments below!