Quick Facts: How Successful Angels Invest
Joey Lo | Sep 17, 2009
An engaging reader, Jim Flower, recently shot us an email and suggested the following topic:
Flying under the radar. Investing in companies that will never get really big, but have the potential to make a few people financially very happy.
I think it’s a great topic. It sounds legit and seems worth considering. Before I offer my take, let’s narrow down the type of angel investors I’ll be referring to throughout this post.
Why Do People Become an Angel Investor?
According to Dr. Scott A. Shane, the author of “Fool’s Gold?: The Truth Behind Angel Investing in America,” some of the top reasons why people become an angel include:
- to find a job
- to make money
- to learn new things
- to get involved with startups
- to give back to the community
The topic suggests “financially very happy,” so I’ll focus on the type of angels that are in it for the money. Please keep that in mind.
55% of Startups Fail Within 5 Years
In an ideal world, you’d just invest in one company that will be a sure win. It mightn’t get very big but it’ll certainly make you “financially very happy.” In reality though, no matter how experienced an investor is, she doesn’t know at the outset which venture will score and which will fail. On average, 55% of startups fail within 5 years. According to Shane’s findings, even accredited angels and those who invest with an organized angel group see a negative return in 40% of their investments. And only 7% of investments account for 75% of all returns. In other words, it’s the few home runs that make up for the losses.
What Do Successful Angels Do?
Savvy investors know they aren’t psychics and aren’t living in an idealized world. They know that many startups will fail so they use a portfolio approach to balance their risks. They invest in a number of companies rather than just one and only scope for those that have a potential payoff of at least 5 to as much as 30x their invested capital in 3 to 5 years. This way, the startups that succeed would generate a return handsome enough to not only recoup their losses but also fatten up their bank accounts.
How Do You Define “Big”?
So, it depends on how you define “big.” According to Angel Capital Association, in 2008, angel groups invested an average of US$281,000 in a single company whereas an independent angel invested between US$10,000 and US$200,000. How much capital in total does the startup need? Does the startup offer that growth potential and 5 to 30x expected payoff within 5 years? If not, financially-focused angels won’t invest in this startup and the founder may have a better chance securing funding from friends and family or non-financially focused angels.
Filed Under: Angel Investing Basics • Picking Winners • Questions • Research Findings
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Lol! I was just thinking of the same thing. We mediate alike! This does sound like an investment in the stock market. OMG The stock market is such a dangerous thing but at the same time, it can be so lucrative. I know people who have lost thousands, and others who gain hundred thousands.
Lol! I was just thinking of the same thing. We mediate alike! This does sound like an investment in the stock market. OMG The stock market is such a dangerous thing but at the same time, it can be so lucrative. I know people who have lost thousands, and others who gain hundred thousands.
Experienced investors know that they should only invest in industries they're familiar with and stay away from those they don't understand. If an investor has no idea what he's getting into, he mind as well play at the casino and hope to hit the real jackpot.
We'd already covered the average 27% annual return in various posts, citing the research findings from the Kauffman Foundation and the Angel Capital Education Foundation. The 27% is the average return from the portfolio: Only 7% of investments account for 75% of all returns. Organized angel groups still see a negative return in 40% of their investments.
Yep — already covered that in various posts and have mentioned it on our Join page.
I wonder if an angel investor would strategically limit investments in the same area of business?
For example if five companies were involved, would you limit the number that were in high tech, or assume that it was worth the chance to go with more in the same field, expecting one would be a jackpot?
According to a recent study conducted jointly the National Angel Investor Associations of Canada and the U.S., the average ROI of formal groups that conduct due diligence and company screening is 27.5%.
In the public stock market, you can choose to invest in a mix of small, risky companies and established, conservative organizations. In the private market, however, all of your angel investments are risky, given that 55% of startups fail within 5 years. Even so, using a portfolio approach helps diversify risks in both public and private markets.
[...] This post was mentioned on Twitter by Alastair Goldfisher. Alastair Goldfisher said: Quick Facts: How Successful Angels Invest http://bit.ly/4rpFTQ via @venturehype [...]
It sounds so much like investing in the stock market. You have some money placed in high risk companies with the hope of explosive growth and income. Then you also have some money in conservative companies for long term growth. By doing both, you spread out your risk in hopes of having a nice reward.