In Angel Investing as Asset Allocation Strategy: Risks, Returns, Homeruns, we reviewed why angel investing isn’t for the faint of hearts. The risks involved can be quite overwhelming.
For the ambitious bunch, though, it’s difficult to resist the attractive payoffs offered by angel investing. If we want to tap into the lucrative potentials and make sure our bottoms are covered, we need to understand the importance of personal asset allocation decisions and strategies.
This installment deals with the typical time required to exit an investment and the easiest way to determine how much to allocate to angel investments.
Angel investments are illiquid assets; you can’t just sell your positions like those in the public stock market. Angel investors primarily make money through liquidity events (e.g. M&A or IPO), which can take years to occur.
Lisa Lambert, Vice President at Intel Capital, said:
It just takes a long time to go from startup idea to a liquidity event. [...] During the boom days, it was like 2.6 years to get liquidity. And today, the latest average from NVCA, the National Venture Capital Association is 8.7 years.
Some suggest you should angel invest the money you don’t need for another three to seven years or longer. But the safest bet is to invest the money you can afford to lose forever. That is, only play with the money you can lose without affecting your lifestyle.
Even if you have a sharp eye for picking promising entrepreneurs, there’s no guarantee as to when a liquidity event will occur, or if it’ll even occur. There are too many factors that’d affect the evolution and progression of a startup.
Joshua Schachter, an entrepreneur-turned angel investor, states, “I’ve been investing since 2006, in 38 deals so far, and I’ve seen exactly one exit so far.”
Thealzel Lee of VANTEC notes, “One angel investor lamented that some of his investments are in their second decade and he has no way of liquidating his initial investments.”
Having said that, there are great exits that have put a huge smile on angel investors’ face too. Otherwise, no one in their right mind would angel invest!
Mint, a consumer SaaS startup, had raised a total of US$32 million over 3 venture rounds before getting acquired by Intuit for a handsome US$170 million. At a mere age of 3 at the time of acquisition, Mint went on to become “The 2009 Poster Child of Early Exits” for angel investors.
Problem is, even the most sophisticated investor can’t say for sure how long it’ll take to get to an exit. Thus, having an asset allocation plan helps you stay on course and understand how much you’re putting at risks.
David Hehman, former chair of North Bay Angels, says that the easiest way to determine how much you want to allocate to angel investments is to create a percentage of your total asset allocation:
If you have X dollars [in investable capital], you indicate that Y percentage will be for angel investing. Then, Stick to that!
To come up with the percentage, you might want to meet with your financial advisor, and discuss with him (and your spouse) how much you can afford to lose. Angel investment money is often called mad money, as it is always high risk.
Let’s say John Doe Jr., Jane Doe, and John Doe Sr. each has $2,000,000 to invest.
John Doe Jr., who’s risk-adoring, allocates his capital this way:
Asset Class: % Allocation ($ Amount)
Public Equities: 20% ($400,000)
Bonds: 0% ($0)
Alternative Investments (Angel Investing): 80% ($1,600,000)
Jane Doe, who’s less risk-tolerant but not exactly conservative, allocates her capital this way:
Public Equities: 40% ($800,000)
Bonds: 20% ($400,000)
Alternative Investments (Angel Investing): 40% ($800,000)
John Doe Sr., who’s the most conservative among the three, allocates his capital this way:
Public Equities: 0% ($0)
Bonds: 100% ($2,000,000)
Alternative Investments (Angel Investing): 0% ($0)
Your asset allocation pie will likely look different. How much you allocate to each asset class would depend on your risk tolerance.
But as you can see, asset allocation isn’t rocket science. You may come up with a percentage yourself to keep things simple, or discuss with your financial advisor if you have a more complex portfolio.
Having an asset allocation plan helps you understand how much money you’re allocating to high, modest, and low risk investments.
Now, let’s hop over to Angel Portfolio Strategy of Brad Feld, Will Herman, Sim Simeonov, Et Al. This article goes over some of the reasons why you should reserve funds for follow-on investments; takes a quick look at the portfolio strategy of these noted angel investors; and discusses the minimum number of angel investments you should make to reduce risks and increase potential payoffs.
* For series, references are published in the last installment of the series.