So you think you can (angel) invest?
Given the boom of startups and almost daily stories of ‘multiples’, ‘unicorns’ and ‘startup millionaires’, it’s understandable that all of us would be curious about the space and how to jump into it!
This article is about my experiences angel investing for 8 years across South East Asia and India, the highs, the lows and the times you want to bang your head against a wall. Enjoy
1. What is Angel Investing?
Conventional wisdom (namely various results after a Google Search) define angel investing as “An angel investor (also known as a private investor, seed investor or angel funder) is a high-net-worth individual who provides financial backing for small startups or entrepreneurs, typically in exchange for ownership equity in the company”
Where I tend to disagree with this is the high-net-worth individual part, unless my collection of vintage pokemon cards suddenly appreciated a LOT without me noticing (just checked, sadly they have not).
That being said, it’s generally best not to invest your retirement fund /kids education fund /cash you need to eat food tomorrow in a startup.
2. How do I start?
The very first step to angel investing is DON’T. First, take a look at your overall financial portfolio, your positions across stocks, real estate, ETFs, bonds, gold and bitcoin (feel confident adding this in now).
If the above sounds like a foreign language, don’t angel invest! Instead, take some time out to educate yourself about a diversified portfolio, basic financial awareness and what you need to do to secure your future (hint: If everything you own is lying in your bank account or a fixed deposit, speak to a fiduciary/financial advisor).
3. How do I start? (part Deux)
Okay, my previous point wasn’t Latin and you’re a master of your financial destiny, now we can get onto why you clicked on this in the first place, the How!
On the face of it, it seems fairly simple. Bright founders (typically within your social network) have an idea that seems like the best idea and projections that knock your socks off.
Year 1= $1mn sales/users/gmv | Year 2 = $4mn … Year 5 = $$$ for YOU
This is where most people tend to jump in both feet first and invest, possibly get their hands burnt and swear off the entire thing altogether :( :( :(
While the numbers are debated, between 75–90% of startups fail (more info). As to why they fail, my friend Pranjal adds in some great points here that he’s learnt growing one of SEA’s leading micro-mobility startups.
4. Whaaaat?
Why in the world would you invest in something with a (75 to) 90% failure rate?
My top reasons below -
- Domain expertise: One of the startups I invested (nCinga) in solved a key problem for garment factories (fairly obscure in the grand scheme of things). It wasn’t sexy, didn’t have newspaper hoardings or clients anyone outside the industry had ever heard of. But damn, it solved one of the biggest problems in a factory, it reduced wastage of raw material by close to 50%!! It was a no-brainer for me to see how this could be adopted and scaled across the industry so I jumped into the company. If you understand a sector deeply and see a company that solves an important problem, odds are it can scale.
- Founders: The founder(ers) are the one of the most important factors that determine a startup’s success or failure (especially at the early stages). When you’re meeting a young company, my suggestion would be to look at the fancy pitch decks later (they are always soooo good) and concentrate on the founder and founding team. If you feel they are exceptional individuals, that’s a good reason to go ahead. Great founders will lead to a great company which may not even be what you originally invested in!
- Example: India’s very first Unicorn (company that hits $1bn in value) Inmobi started as an sms-based search provider. In chats with some of the early investors, very few understood the space in detail but everyone unanimously agreed that Navin, Mohit, Abhay and Amit were a fantastic team so they invested. Inmobi pivoted to mobile advertising two years later (investors once again scratched heads but supported the team)and the rest is history
- Unlocking value: This sort of follows onto domain expertise, if you feel you could help a startup scale quickly (through your existing network, expertise etc) you can invest in the company and act as a mentor/guide as well. This gives you an opportunity to learn and see some part of the entrepreneurial journey without jumping into the company (though that could be a great next step!)
5. The pitfalls
Some of the key things to keep in mind when investing in a startup (this is an extremely vast topic so sticking to a few key points)
- Forget about the money: Mentally say goodbye to this money (I HAVE to reiterate this point). The chances of failure are extremely high so be ready to lose this investment completely
- Liquidity??: Startup investments are highly illiquid. If you suddenly need the money or want to ‘exit’, you will have to wait for chances (liquidity events) that are few and far between.
- Paperwork: Even if you were college roomies and ‘BFFs forever’, make sure everything is in black and white. There are several resources online to help you understand term sheets, shareholder agreements and the myriad paperwork involved. Ideally, involve a lawyer to help formalize these.
- Tax: Depends on where you live, you can have various tax implications that arise from a startup investment which can catch the unsuspecting investor by surprise (worst case with a dreaded notification from the Tax Department). Work on understanding the liabilities that arise from your investment.
- Dilution: Because of several reasons (read more here) your percentage ownership goes down with every round of funding the company raises. This is a good thing as owning 1% of a $100mn company is far more valuable that 10% of a $1mn company. If you want to maintain your ownership, read more about pro-rata rights and how it affects you.
- Tracking: Spend time talking to the founders and team, both from the perspective of helping them as well as encouraging them to report their metrics to you at regular intervals (monthly ideally).
- Control: So you gave your friend a $20,000 cheque, now you want to decide who they hire, which markets they enter etc. This won’t work.
As an angel investor, you will have limited rights and controls (ideally you hired that lawyer and put these into your initial agreement) and you won’t have a say in day-to-day matters of the company.
6. Exit!!!
In that rare scenario that your investment reaches an exit (WOOOHOOO), this could take several forms.
- The most likely form of exit for most startups is an acquisition by a bigger company. Depending on the stage you entered the company, this could result in a fairly good return for you (20–100% IRR) though there are things to keep in mind.
Large companies will typically require early investors to exit so you will need to sell all your shareholding (no keeping half). They may also offer some part of compensation in their stock (there’s no right answer here, personally I prefer hard cash) and may offer less in cash if you opt for that. - The founders/company may also offer to buyback your shares, this typically results in a lower IRR but frees up your cash to invest in the next company (or a new Mercedes if that’s how you roll).
- Secondaries. Almost as rare as unicorns (kidding), a private investor or fund may offer to buy out your shares as part of a secondary sale (where an investor purchases shares from existing shareholders as opposed to a new issue by the company).
- Dare I say it? An IPO….. One of the rarest forms of exits in the recent times, this is the ultimate form of exit and typically means you’ve made a fairly strong return, possibly greater than 100% IRR (this is a FANTASTIC result)
Summing everything up, investing in startups is incredibly risky, highly frustrating, occasionally terrifying but ultimately a rewarding experience (maybe not in cash :P)
If you want to know more about this, feel free to ping me on LinkedIn and I would be happy to tell you whatever little I have figured out so far!
