Angel Portfolio Strategy of Brad Feld, Will Herman, Sim Simeonov, Et Al.

This is Part 3 of a series on asset allocation strategies for angel investors. Please read Part 1 and Part 2 through the links below:

• Angel Investing as Asset Allocation Strategy (1): Risks, Returns, Homeruns explains why you may want to allocate a portion of your investable assets to angel investing, discusses risks and returns of angel investing, and covers the concept of home runs.
• Asset Allocation Strategies (2): Easiest Way to Determine How Much to Allocate to Angel Investing talks about how long it typically takes to exit an investment and shows you the easiest way to determine how much to allocate to angel investments.

Here, we’ll go over some of the reasons why you should reserve funds for follow-on investments; check out the angel portfolio strategy of several noted investors; and determine the number of angel investments you should make to reduce risks and increase potential payoffs.

Reserve Money for Follow-On Investments

Out of the funds you’ve allocated to angel investing, you’d also want to reserve a portion for follow-on investments. This will help keep your portfolio companies afloat, mitigate risks, and protect your position from getting significantly diluted, especially in a down round.

Brad Feld of Foundry Group states: “I always assumed I’d double down on each investment before the company either raised a VC round or was acquired (so – when I put $25k in, I was really allocating $50k to the company.)”

Will Herman, TechStars mentor and Boston angel investor, reasons:

Keep some powder dry for subsequent rounds – while the best return in a successful investment comes from investing earlier, holding some cash back to see how the company does and to play alongside any institutional money that comes into the company mitigates some risk and ensures you’re playing on the same terms as the rest of the investors.

John Huston of Ohio Tech Angels Fund said: “The angels’ best protection against a ‘down round’ is to have adequate dry powder to preclude the need to seek new outside investors.”

Don’t throw good money after bad, though. Like Mark Suster of GRP Partners suggests, “[if] the management team fails to deliver against even a modest set of expectations, doesn’t ship product, has internal conflict, demonstrates a lack of maturity” or if there are any other indications that the venture isn’t performing or isn’t hitting milestones, then you’d obviously steer clear from doubling down.

So, use your best judgment to decide whether the company worth your additional investment. While some startups might die despite the extra time and money, others might just work their magic and become world-class enterprises!

Angel Portfolio Strategy to Increase Expected Returns

In Angel Investing as Asset Allocation Strategy (1): Risks, Returns, Homeruns, we found that almost 5 out of every 10 companies fail. If you invest in only 5 or fewer companies, there’s a high chance that most, if not all, of them will fail. You’ll need to invest in more companies to improve the chance of success.

Sim Simeonov (angel investor, entrepreneurial computer scientist, and former venture capitalist) and Jeff Miller (angel investor and hedge funds advisor in the quantitative/automated trading space) each created computer simulations to calculate the hypothetical returns of angel investing.

Simeonov found that median returns increased substantially with portfolio size – the more companies you invest in, the better you do:

• The median expected return increases by more than
  * 50% when a portfolio grows from 5 to 10 companies;
  * 100% when a portfolio grows from 5 to 20 companies.
• The probability of making an over 2x returns on invested capital goes up by more than 50% when a portfolio grows from 5 to 20 companies.

Miller’s takeaway from his experiment: “Angel investors can expect favorable payoffs with only 10 deals, but it takes at least 20 investments to truly be safe.”

Simeonov offered a note of caution, though (emphasis added):

My advice to angel investors is to look beyond the portfolio effect. It is necessary but most likely not sufficient. It is not a panacea, especially in a world where there are more and more sources of seed-stage capital. Good deal flow and the ability to win deals will matter more and more in the coming years. Developing real differentiation above and beyond being able to write a quick check is the key.

Angel Portfolio Strategy Tip: If you’re unable to allocate money to invest in 10 companies, you may want to consider investing in an angel or private equity fund for better diversification.

Ready to create a solid, proven angel investment plan? Good. Let’s go!

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