Angel Investing as Asset Allocation Strategy: Risks, Returns, Homeruns

Image by Mykl Roventine

Got ambitions for high-payoff potentials? Allocate a portion of your investable capital to angel investing, a form of alternative investments that offer high risk, high return opportunities.

William S. Podd, executive director of Landmark Angels, suggests, “Angel investing, with its historical high risk/high reward strategy, can provide an opportunity for significant returns for high net worth investors as part of an asset allocation strategy.”

Amazon, Facebook, Google, Mint, PayPal, and Yahoo are just some of the high-profile companies that have made their angel investors very happy.

High Risks/High Returns

A study by Scott Shane, author of “Fool’s Gold?: The Truth Behind Angel Investing in America,” reveals that accredited angel investors see a negative return in 40% of their angel investments, and 7% of investments account for 75% of all returns.

Roughly speaking, out of 10 angel investments, 3 to 4 will fail, 4 to 5 will either do okay (generate some return) or will be “walking dead” (survive but generate little or no return and not dead enough to be a write-off), 1 or 2 will be home runs that make up for the losses and generate a handsome return to angel investors.

Brad Feld, managing director of Foundry Group, explains the concept of home runs:

Understand the difference between 0x and 100x: I’ve had two of my angel investments return over 100x each.

Since I had a strategy of investing the same amount in each company, all I needed was one 100x to allow me to have 99 companies completely flame out and return 0 and I’d still break even.

With two investments at over 100x, I now have a built in gain of significantly over 3x across all of my investments since I’m [sic] made about 75 of them and I’m now deliciously “playing with house money” on all of the rest.

Financial Returns: Angel Investments vs. Other Asset Classes

Few years ago, the Ewing Marion Kauffman Foundation and the Angel Capital Education Foundation conducted the largest study on the financial returns of angel investors in North America and released a report in 2007, showing that angel investors participating in organized angel groups achieved an average 27% internal rate of return (IRR) on their angel investments.

Overall, this set of angel investors affiliated with angel groups experienced exits that generated 2.6 times their invested capital in 3.5 years from investment to exit. This return compares favorably to that of other private equity investments, including those of early-stage venture capital. Seven percent of exits generated returns above 10 times their initial investment.

New Series: Asset Allocation Strategies for Angel Investors

You see, angel investing is a high-risk, high-payoff activity. To help investors tap into the potential lucrative returns without risking more than what they can stomach, we’ve prepared a new series on asset allocation strategies, which studies what veteran angel investors recommend in respect to personal asset allocation and effective portfolio building.

Next, Easiest Way to Determine How Much to Allocate to Angel Investing.

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