Being an angel investor has a certain cache. You’re sought after by entrepreneurs and assess the value of their ideas. You choose whether or not to invest, and how to make those investments – whether it is a self-directed IRA or with non-retirement funds. And when things go well, you make money and you are a part of getting a business off the ground. In this light, who wouldn’t want to be an angel investor?
An angel can choose how he or she collaborates with entrepreneurs and other investors in a variety of ways that fit their experience, wealth, interests and time availability. The rewards are many, assuming you can check yes to these basic caveats:
- Legally, you must have the wealth or income to be an accredited investor.
- Personally, you must be willing to lose your investment money, should have a portfolio strategy, and use good investment practices.
Angel investing offers some financial rewards: first, consider the potential financial returns. A study by ACA found that the overall return on 1,100 plus angel exits was 2.6 times the money in 3.5 years, or about 27% gross Internal Rate of Return. Not bad compared to other types of equity investments. Even so, it’s important to understand the details. More than 52% of those exits lost some or all of the investment and 7 percent provided nearly all of the returns. This means that angels need to start with a strategy to make multiple investments to minimize risk and increase the chance of good returns.
Angel investing can also help diversify your overall investment portfolio. Ryan Feit, CEO of SeedInvest, put it this way: “Allocating 5% of your overall portfolio into angel investments can increase returns while lowering volatility. This is because early-stage, private companies generally have a low correlation with traditional asset classes, such as stocks and bonds. A recent SharesPost whitepaper concluded that allocating 5% to private growth companies could increase the returns of a traditional portfolio by 12%.”
While returns are the measuring stick for any kind of investment, investing in early-stage companies provides a whole set of additional, hard to find, personal rewards. Some angels want to help their communities grow. Others want to help women entrepreneurs or support alumni from their university. Others favor a vertical market segment. Still, others are looking for alternative investments to supplement retirement that provide value while avoiding the volatility of the market. Because angel investing is a marathon, and not a sprint, goals play a big role. Here are some of the personal rewards:
- Meet interesting people with fascinating ideas – Top entrepreneurs are the best communicators, getting across their technology or medical innovations in ways nearly anyone can understand while also explaining their business models very well. You can feel their tremendous passion and see how fast the wheels in their brains are going. Through angel investing, I have also had the pleasure of meeting other investors. Often, we have highly different backgrounds, yet we share a common core that builds great bonds, leading to long-lasting, true friendships. And let’s not forget the great food and beverages we enjoy as we analyze and debate our next investment.
- Support what you care about – Since angels decide which companies they want to invest in, they can put their own money in the kinds of businesses that are the most important to them. This might be industry sectors you have experience in or entrepreneurs who are alumni of your university or supporting a demographic you care about such as women entrepreneurs.
- Know you’re doing good – As Feit says, “Unlike any other type of investment, startup investing provides the opportunity to invest in innovation and to feel real ownership in the companies that you invest in. Every year, angel investments create thousands of revolutionary and life-changing technologies.” I’ve met so many angels who are also proud that the companies they invest in create new jobs.
- “Entrepreneurship without the responsibility” – Super Angel David S. Rose coined this phrase in his 2014 book “Angel Investing: The Gust Guide to Making Money and Having Fun Investing in Startups.” Entrepreneurship is exciting. As I wrote a few years ago, one of my favorite angels has said how much he loved starting his very successful company and selling it for a great return, but he didn’t really enjoy the part in the middle—running and growing the company. As angel investors, we know that the responsibility for a company’s success lies with the CEO and we can enjoy being involved with the company without having the responsibility of leading “in the middle” to get to a great exit.
- You choose your investments – If you have reached retirement age or are planning for your golden years, angel investing can be a smart way to add to your self-directed IRA investments. Angel investing gives plan owners the control to grow retirement income and the freedom to invest in startups that are appealing.
- Learn new skills – Angel investing offers something new for everyone. Learning new things like deal terms, the most effective way to mentor entrepreneurs, or how to be a good board director can be lots of fun. Sometimes gaining these skills can also lead investors on new life paths. For instance, one reason angel investing is attractive to women is because it’s a fast track to serving on boards of directors and then leveraging that experience to become better candidates to serve on corporate boards.
- Apply current skills in new ways – Angel Barbara Clarke is an example of how an investor’s background can contribute to the angel process. As she told me recently, “Everyone on a due diligence team has their own unique expertise and experience. For example, angels with journalist backgrounds are good at research and interviewing. My background is management consulting, and I’ve found that I am comfortable with competitor and market analysis, even in industries and fields I am unfamiliar with.”
Before making investments, angels need time to understand the field and do some planning. Here are three “big picture” aspects of the job:
- Understand the risks and rewards of angel investing. It’s true – angel investing is a ton of fun. But investing in early-stage companies is financially risky, as mentioned earlier in this post. Just one or two investments out of ten provide a 10X return or more, equating to the bulk of your return portfolio success.
- Develop your personal strategy for investing. Considering the risks, angels need to invest in lots of companies and be ready to lose money. That’s why having a portfolio strategy early on is so important. Bill Payne, who has made 60 angel investments, recommends an angel portfolio strategy with these components: determine the total amount of money you will invest over time in startup companies, how many checks or companies you will support and what kinds of companies to invest in. If you make at least ten investments over time, consider dividing your total angel investment by 10 – or ideally 20, for companies that need follow on capital. Smart money is invested in companies or sectors that you know and understand. It’s also wise to choose investments based on what motivated you to be an angel. For instance, I personally like to invest in true startups where I live and have women on the leadership team. There is no right answer here – it’s your money, so invest in what is important to you.
- Determine where to find good companies to invest in and the right vehicle for you. These days there are so many ways you can find deals and do the work of angel investing. If you are part of the entrepreneur ecosystem and can easily attract opportunities on your own, solo angel investing or informally investing with friends could be the way to go. Or you can build on the power of more people by aligning with angel groups, accredited platforms or accelerators. The Angel Capital Association website includes a directory of member angel organizations located in every American state and five Canadian provinces if you want to explore options for yourself. As you explore these options and pick what is right for you, take advantage of events and community activities that connect you to investment opportunities.
Angel investing is a unique, complex but also a highly rewarding way to invest. Although not everyone will want to dedicate the time and energy required to be an active angel investor, for those that do, the benefits offer a payoff unlike any other investment opportunity. Think about your own situation and pick the options that best fit your interests, capabilities, goals for your retirement funds and availability. Continue to learn as much as you can about angel investing before diving in, but know up front that it is one of the best things you can ever do.
Guest blog by Marianne Hudson, Angel Capital Association
*Mainstar’s role as custodian of self-directed accounts is nondiscretionary and/or administrative in nature. This information is for educational purposes only, and should not be construed as investment, legal, tax or financial advice or as a guarantee, endorsement, or certification of any investments. Mainstar encourages individuals to consult a financial or legal professional when making investment decisions.