Create a Solid Angel Investment Plan to Capitalize on Portfolio Effects

This is Part 4 of a series on angel investment asset allocation strategies. Please read Part 1, 2, and 3 here:

• 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.
• Asset Allocation Strategies (3): Angel Portfolio Strategy of Brad Feld, Will Herman, Sim Simeonov, Et Al. goes over some of the reasons why you should reserve funds for follow-on investments and takes a quick look at the portfolio strategy of some noted angel investors. The article also highlights the minimum number of angel investments you should make to reduce risks and increase potential payoffs.

Here, we’ll show you a way to determine how much to invest in each deal; talk about typical deal size we’ve been seeing; and discuss how sticking to your angel investment plan can help you leverage the market climate.

Angel Investment: How Much to Invest in Each Deal

After reading and completing the steps outlined in the articles above, you may then determine how much to allocate to each deal and decide on an investment timeframe.

Example:

• You’ve allocated $1 million to angel investing.
• You want to invest in 25 companies.
• You decide to allocate ($1,000,000/25 companies) = $40,000 per company (follow-on reserves included), assuming you plan to invest an equal dollar amount in each company.
• You want to invest in 5 companies per year.
• It’ll take you (25 companies/5 companies per year) = 5 years to make all the angel investments.

David Hehman, former chair of North Bay Angels, notes that each company “may take 3 to 7+ years to succeed/fail.” Those that succeed will provide additional funds for future angel investments.

Typical Angel Investment Deal Size

In the example above, we calculate that you may invest $20,000 (plus $20,000 follow-on reserves, which comes to a total of $40,000) in each company. But how much to allocate to each deal/company is really up to you.

Let’s look at the deal sizes we’ve been seeing as a point of reference:

• In 2008, Angel Capital Association found that an independent angel invested between US$10,000 and US$200,000 in a single company.
• In his book, Fool’s Gold?: The Truth Behind Angel Investing in America, Scott Shane finds that the typical (median) angel investment is US$10,000, whereas the average investment is US$77,000.
• Though we don’t have research to back this up, it does appear that noted angel investors are investing at a minimum of US$25,000 (plus follow-on reserves) per company.

You might write the same check size for all companies, or you might allocate more money to your favorites. No matter how you go about it, remember to also allocate a portion for follow-on investments.

Stick to Your Angel Investment Plan and Timeframe

Hehman then points out how sticking to your plan can help you leverage the market climate:

Another note about time is that when everyone is hibernating in bad time, this is a great time to invest.

If you allocate a certain amount for each quarter or year, you can stay investing evenly through lean times.

When the markets are bubbling or overheated, it is the time to be disciplined, and stick to your plan, not adding any more to your portfolio than you projected.

What Hehman is saying is that if you’ve decided to invest in 5 companies every year, don’t invest more than planned when there’s the investment climate it too “hot,” and stick to your angel investment plan even during bad times. Fact is, many greats companies like Apple, Hewlett-Packard, and Microsoft were started during the recession.

Sim Simeonov, an angel investor and a former VC, also stressed that financially-focused angel investors must invest “thoughtfully and consistently over a period of years to take advantage of portfolio effects.” Angel investing “isn’t something to casually engage with.”

Simeonov concluded:

Angels should start by asking themselves the following question: “How much can I consistently invest in startup companies for at least five years, regardless of what the public markets do?” Then, they should take this amount and look for ways to invest in 5 or more companies per year.

Coming Up

Next, we’ll look at multi-stage investments, investment styles, net worth implications, and successful exits/returns allocation.