Angel investing is risky and potentially very rewarding. You already know that. Even if your primary intention is to encourage the entrepreneurial spirits in your community, it’d be nice to make money from your “semi-charitable” investments too. If you don’t expect to make money, you’re a philanthropist, not an angel investor.
Why are some investors more successful than others? What makes them different from the average ones?
Successful investors understand risks and they use risks to their advantage. For this reason, we started a 2-part series on risks, and on improving the odds of turning someone else’s ideas into profits.
The 4 primary types of risks are:
We’ve looked at Financial and Market risks in Part 1. Here, we’ll look at People and Product.
People / Execution Risk
Time and time again investors all around the world place significant weight on the founding team. You’d want to have the right talents. You’d want to know that the team has what it takes to execute their oh-so-brilliant plan. You’d want to bet on the jockey not on the horse.
According to Harvard Business School’s working paper, “Performance Persistence in Entrepreneurship”:
All else equal, a venture-capital-backed entrepreneur who starts a company that goes public has a 30 percent chance of succeeding in his or her next venture. First-time entrepreneurs, on the other hand, have only an 18 percent chance of succeeding, and entrepreneurs who previously failed have a 20 percent chance of succeeding.
Bet on an A-team. In an A-team, at least one of the founding members has a history of success. Head over to Startup Team That Adds the Steam and Doing Due Diligence on Startup Team to find out what an A-team looks like.
Note, though, we’re not suggesting you should automatically reject inexperienced entrepreneurs. After all, angels are more likely than VCs to back first-time entrepreneurs. Ultimately, you need to ask yourself whether you believe in the team or their products.
Naval Ravikant of VentureHacks once said, “The team matters more in enterprise deals, traction matters more in consumer deals.” So, a consumer Internet startup that has traction run by an inexperienced team might be just as good.
Some evaluation questions include:
Product / Technology / Technical Risk
The product or technology is the central basis of a startup’s value proposition. No product, no business. A mighty cool product without applications is still mighty useless. You can be looking at a solar-powered torch so sleekly designed that it’ll put Apple to shame. But if the torch only works when the sun is out, shining brightly in the sky, then the torch hardly solves anything. Who needs a torch when you can see clearly under the sun?
If you think the technology is cool but not quite sure about its application, consult with independent experts who get the technology. Ask them to validate and assess the risks before making any investment decision.
If you’re looking at a unique product / technology that actually solves problems, conduct searches on patent applications and make sure the product hasn’t infringed existing patents on the market.
If there’s possibility of infringement but you’re convinced of the technology’s potential, talk with an experienced lawyer to see if there are any workarounds. Otherwise, you may want to simply pass on the opportunity and save yourself some sleepless nights.
Some evaluation questions include:
Higher risks yield higher returns. Understand the risks involved and weight them against potential rewards. Learn to adore risks and use risks to your advantage.
For Jason Cohen, an angel investor and the founder of Smart Bear Software, he wants the entrepreneur to list the known risks so he can evaluate them. He wants to see that she’s honest, that she has both eyes open. And he wants to know how she’s addressing and reducing risks.
If the entrepreneur claims that risks are minimal because she’s “in control” or “in the know,” it’s likely that she isn’t even aware of the risks. Cohen doesn’t invest in such entrepreneurs.
Keep these in mind when you’re evaluating a potential investment.
And think ahead. Take calculated risks. That’s how you can improve the odds of profiting from promising startups.
* For series, references are published in the last installment of the series.
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