This post is an attempt to clarify and explain (and rationalise?) my present thinking around angel investing. It helps me organise my various thoughts into one coherent picture, and I hope it serves as a useful data point for other current or would be angel investors. As with all things involved with investing, everyone’s specific situation is different and this is not financial advice.
1. The Economics of angel investing
Over the last 5 years, my wife and I have made 10+ angel investments into startups, and before 2021, we also deployed capital into 50+ ICOs and various crypto projects. These numbers are by no means large by Western angel investor standards, however they highlight the point that you cannot expect to angel invest if you are not ready to deploy capital many times, over many iterations, learning as quickly as possible (and likely losing a lot of money). The following explains why this is core to angel investing.
To understand the economics of angel investing, let’s look at some examples. Some people who start out angel investing will believe that the company they invest in is special, and that it can at least double or triple their money. Let’s say they invested $20,000 and the startup manages to succeed, exiting at 5x (a good result) without any dilution (highly unlikely). Great, their $20,000 has now turned into $100,000. That was easy, right?
| Stage | Amount | Multiple |
|---|---|---|
| Investment | $20,000 | 1x |
| Exit | $100,000 | 5x |
| Profit | $80,000 | +4x |
So now you do another angel investment, but this time you invest $50,000 because your previous angel investment worked out so well. Maybe you’ll hit it out of the park again and 5x your money. However if we look at the statistics of startups (and even small businesses), we’ll see that about 90% of startups will fail. For the 10% that actually make it, what does ‘making it’ look like? This will range between 2x-1000x of the money you put at risk. But to get to the point of something that provides a 10x or higher return will be even more unlikely, which I’d assume is much less than 1%.
So with that in mind, how likely is it that in our previous example the angel investor will actually make a return? It is less than 10%, and most likely even less due to the likelihood of startup success in highly competitive markets, over a 10 year period (the average period it takes for startups to ‘exit’). Most likely the angel investor will loose their money.
| Stage | Amount | Multiple |
|---|---|---|
| Investment | $20,000 | 1x |
| Exit | $0 | 0x |
| Profit | -$20,000 | -1x |
But, if the angel investor spreads their investments so that they are more likely to hit those 10% of startups that succeed, what would be the result? Let’s say they invest $20,000 in 100 startups, totalling $2,000,000. Now assuming all their positions don’t get diluted and they can maintain their ownership percentages, and 10% of the investments succeed at 5x (a reasonable result), then 10 startups have returned $100,000 each, totalling $1,000,000.
| Stage | Amount | Multiple |
|---|---|---|
| Total Investment (100 deals) | $2,000,000 | 1x |
| Failed Investments (90%) | $0 | 0x |
| Successful Investments (10%) | $1,000,000 | 0.5x |
| Total Return | $1,000,000 | 0.5x |
| Net Result | -$1,000,000 | -0.5x |
But hold on, the angel investor started with $2,000,000, so they actually lost money! Note: we assumed a 5x result. However the more realistic scenario is that it’d be a spectrum of some returning 1x, others returning 3x, and some really rare ones returning higher.
If we take a more positive scenario of 10 startups succeeding, with 4 returning 1x ($80,000), 3 returning 5x ($300,000), 2 returning 8x ($320,000), and 1 returning 10x ($200,000), then the result is $900,000. Even less return than before! So the picture is not looking good for this angel investor.
| Stage | Amount | Multiple |
|---|---|---|
| Total Investment (100 deals) | $2,000,000 | 1x |
| 4 Startups Return 1x | $80,000 | 0.04x |
| 3 Startups Return 5x | $300,000 | 0.15x |
| 2 Startups Return 8x | $320,000 | 0.16x |
| 1 Startup Returns 10x | $200,000 | 0.10x |
| Total Return | $900,000 | 0.45x |
| Net Result | -$1,100,000 | -0.55x |
Ah, so angel investing is not so easy eh? The promise of riches is more likely a promise of ruin. If you’ve read this far then you probably believe that there is a solution to this, which there is! Find only the startups that could potentially 100x your money, then you’re bound to only get 100x returns, right?… Well, remember that 90% of startups will fail, so you’d be very lucky to find one startup that returns 100x. E.g. you invest $20,000 into 100 startups, totalling $2M. All startups fail except 1, then that 1 startup returns $2M!
| Stage | Amount | Multiple |
|---|---|---|
| Total Investment (100 deals) | $2,000,000 | 1x |
| Failed Investments (99%) | $0 | 0x |
| 1 Startup Returns 100x | $2,000,000 | 1x |
| Total Return | $2,000,000 | 1x |
| Net Result | $0 | 0x |
Great result for the entrepreneur and startup! However you as an angel investor are in the same position you were in when you started investing, and it is 10 years later and you could have made a much better yield in the S&P or holding BTC. :(
What if instead of aiming for 100x startups, you only go for the incredible outliers - the 1000x startups. Assuming the same likely scenario plays out where only 1 startup makes it out of 20, so your initial $20,000 becomes $20M.
| Stage | Amount | Multiple |
|---|---|---|
| Total Investment (100 deals) | $2,000,000 | 1x |
| Failed Investments (95%) | $0 | 0x |
| 1 Startup Returns 1000x | $20,000,000 | 10x |
| Total Return | $20,000,000 | 10x |
| Net Result | +$18,000,000 | +9x |
Now this is the financial return we were promised right? Great job. To continue this trend, you’ll just need to only invest in the startups that could exit at 1000x, and skip all the ones that will return less. Easier said then done. This is why a lot of angels and VCs are annoyingly all about the global winner take all startups - they're the ones that are most likely to return 1000x+.
But how do you find these mythical 1000x startups?
2. The Art of finding great startups and entrepreneurs
If your job is to find the startups that can return 1000x, where do you find them? One helpful framework is to think of it from the perspective of the entrepreneur who is building that 1000x company. Where are they? What drives them? What would they do and how would they see the world?
Location, location, location!
For these entrepreneurs, how likely are they to be in your local city? If you’re living in Silicon Valley, Shenzen, London, or other major technology hubs, then yes, maybe those entrepreneurs would be there. If they're willing to move to those locations, then great, that's a positive signal. Why does the city matter? There are a lot of emergent things that happen when surrounded by an abundance of people, capital, and business. Most of these things are good for startups.
If they are building something to take over the world, what would their ambitions look like? Would they want a very balanced life or would the company be all consuming in their life? If we look at YCombinator, arguably the only accelerator that matters (when you look at the numbers), the first ‘test’ is whether the entrepreneur will uproot their life and move to Silicon Valley for 3 months. It’s a pretty low bar, but most people in the world are average, would make excuses, and not take that risk. For the ones that do, those are the types of entrepreneurs that are more likely to be unstoppable in their quest to greatness.
There are of course exceptions. So many exceptions. Even before Silicon Valley had such an outsized influence on creating startups, people were finding and creating globally relevant companies all over the world. But the question for you, as an angel investor, would be how likely are YOU to be able to find those exceptions? If you have absolutely no special insight, networks, or something that allows you to find and filter entrepreneurs, then I’m afraid angel investing is not for you. However if you do have some special insight, network, or ability, then you may just be able to find those very rare and special entrepreneurs.
The person behind the mask
Entrepreneurs come in all shapes and sizes, on all levels of various spectrums. They are the ones that will create immense value in the world and by all accounts, founder CEOs will outperform manager CEOs every time. So the next question to ask: do you understand this entrepreneur? Can you relate to them? If not, then you will have a difficult time evaluating whether they could be that entrepreneur that hits the mythical 1000x return.
One important aspect for angels to consider is whether they are value aligned with the entrepreneur, for if this is the 1000x startup then it will take at least 10 years to reach that stage, and most likely the entrepreneur will at times look towards the angel investor for either advice or friendship. Are you ready for that, or more importantly, do you want to be in that position? Can you essentially be their sounding board or therapist if needed?
As an angel investor, investing in the very early stages, you are essentially investing in the entrepreneur (or entrepreneurs). Their startup idea will most likely change, pivot, or look completely different to what the initial idea/deck was. This is just the path of startups. Are you ready and able to take this journey with them?
A history of doing
As I mentioned, in the very early stages the idea will absolutely evolve and change. The only constant is change in the world of startups. So if you know this is fact and an entrepreneur pitches you on their idea or business, you need to remind yourself that the idea will change significantly. Therefore you can’t fall in love with the idea, as the idea will evolve as the entrepreneur iterates and learns.
What actually matters in the early stages is whether you believe this entrepreneur (or entrepreneurs) are able to relentlessly learn, iterate, and build towards the mythical 1000x company. This is nearly impossible to do as by definition, the entrepreneur is just getting started. However you can evaluate their history - not in the sense of academically evaluating it, but you can see broad trends in what they did previously, how they approached things, and how quickly they learn.
This is an art, rather than a science. One way I think about it is how quickly do they learn and apply those learnings with momentum.
When you interact with enough entrepreneurs, you’ll begin to hone your skills in evaluating BS vs real world ‘spikes’ and trends in someone’s life. So the lesson here would be to help and interact with as many entrepreneurs as possible, then you’ll begin to see broad trends that differentiate doers vs talkers. You’ll be amazed at what you can learn about someone in a 10 minute conversation, or what you can discover about someone’s persistence when you help them in some way.
3. The arrogance of advice
Vinod Khosla, co-founder of Sun Microsystems and now founder of the famed VC firm Khosla Ventures has a famous saying:
90% of investors add no value to companies, 70% of investors add negative value
What he highlights, which I fully agree with, is that investors who have not been through what the entrepreneur has been through, cannot possibly understand or give constructive advice. Most investors have never built something themselves, haven’t suffered through trying to make payroll, haven’t fired anyone, haven’t had sleepless nights trying to resolve a core business issue, the list is endless…
If you, as an angel investor, have been through similar scenarios, then you would already understand that every situation is different, especially if we consider the rate of technological change and market restructurings. So there is an arrogance of investors who believe that their piece of advice will greatly help the entrepreneur, or worst, they give advice expecting that the entrepreneur will exactly follow it. Ugh, the arrogance of thinking you would know better after thinking about a problem for 5 minutes, when the entrepreneur is likely thinking about this problem non-stop.
So what should the angel investor do? Are they just ‘dumb’ money? Well, yes and no. I believe that in the very early stages, when the core product or market is not entirely clear, then some advice or suggestions can be helpful, if you’ve also been in a similar stage of a companies lifecycle. Beyond that point, your advice and suggestions should be strictly limited, unless specifically asked. You should also ensure the entrepreneur gets a few different conflicting viewpoints, so they understand that there is no clear right or wrong decision, as a lot of advice is just nostalgia (when times were different).
(This section is not for ‘new’ entrepreneurs who are just getting started, hackathons, etc. For those, simple startup advice can be quite helpful, as long as it is grounded in the startup stages. E.g. don’t give scale advice to someone who is pre-idea.)
Where angel investors can be most helpful to early stages startups is by helping them multiply their efforts. If the entrepreneurs efforts are going into sales, then help them fill the sales pipeline with relevant leads. If they’re raising a round of funding, help get other investors excited about them and invested. If they’re hiring for a role, help them find relevant candidates. If they’re having difficult time in someway, be there for them and help them as much as possible.
Unfortunately I've seen many entrepreneurs who have wasted vast amounts of time and effort following the advice of some investor, when the entrepreneur intuitively knew what approach they should have taken. Don't be this type of investor, assume that your advice will have a negative effect to limit how much 'input' you give (unless specifically asked ofcourse).
4. Randomness and luck
Some people think that the world is entirely random and that the world happens to them, so everything good in their life is entirely due to luck. Other people think that everything in their life is that way because they designed it that way, that they made it happen. I think the truth is somewhere between these polar opposites. Yes, there is a lot of luck and randomness in life. I happened to be born in Australia, had great parents, and am fully able bodied. That’s pretty lucky! At the same time, there are some things I did in life I was very intentional about, namely moving towards risk, which created moments where I could be more ‘lucky’.
Luck in discovery
In angel investing (and investing in general), I believe the same applies. Randomness and luck play a huge role, but at the same time you can manufacture more ‘luck’ in your life so you are more likely to create a good result. If you happened to be room mates with Mark Zuckerberg when he was just starting Facebook, then that’s pretty lucky! However if you were thinking about social networking, invested in a few social networks already, and were on the look out for social networks at the time Zuck was getting started, then you manufactured that luck! This was in fact what happened with Peter Thiel, where he subsequently made the first large angel investment into Facebook.
So what are some ways you can manufacture more luck in angel investing? Perhaps it would be writing posts like this one, where entrepreneurs whom are aligned with your way of thinking may come across and reach out to you. Or perhaps you volunteer to speak at conferences, participate in accelerators and hackathons, or just try to be as helpful as possible to entrepreneurs. Maybe you make a few angel investments, spend incredible amounts of time with those investments and try to be super helpful, then leverage that goodwill and networks to find more potential entrepreneurs. The idea here is that you want the top of your ‘funnel’ to be as wide as possible, then you’ll be more lucky with the small part of the funnel where you actually make angel investments.
Luck in investments
What was the difference between MySpace and Facebook? Why did Facebook succeed, but MySpace failed? The angel investors in MySpace must have believed that they were so lucky to be invested in the largest and most successful social network at the time. But then out of ‘nowhere’, Facebook comes along and ends up taking the entire market. In this case, was there anything the MySpace angel investors could have done differently?
Well, most likely not. The angel investors were already invested into the most successful social network at the time. You couldn’t have asked for a better result. But unfortunately for them, they were on the wrong side of history. This highlights the amount of luck it takes to be successful as an angel investor. Even if you did all the right things and managed to secure a great financial position in the leading company of the time, the capitalistic market forces are brutal and can destroy any perceived value you thought you had secured. In short, you were unlucky.
So as you make angel investments, understand that when you make them, there is a lot of luck and coincidences that can happen that will change the course of the company you invested in. There is not much you can do about this. You cannot over rationalise the winners or the losers, as sometimes it is just the market, regulation, or competitors that end up having a huge influence on your position.
Once you understand this, you’ll be very humbled. This is why the ‘super angels’ in places like Silicon Valley are so humble. They understand that probably more than half of the reasons for the success of their angel investments is just pure luck, by forces entirely outside their (and at times, the entrepreneur’s) hands. So don’t give yourself too much credit for when it goes right, and don’t beat yourself up too much for when it goes wrong. It is what it is.
5. Applied Learning
What is the take away of this post? If I were to summarise, it’d be to angel invest knowing that you’ll most likely loose the money, you’d have to be incredibly lucky to make a return, and any return you make is most likely not because you did anything to influence that result. That’s not very inspiring, is it?
My belief is that angel investors should not decide to angel investor only for pure returns. Something else needs to be driving them. Usually it is because they want to be part of the entrepreneur’s journey, living vicariously through them because they also have an entrepreneurial spirit. They need to love the journey, the ups and downs, the ‘starring into the abyss and eating glass’… if you’re not up for this then you shouldn’t be an angel investor. It is definitely not for everyone, and generally you can get more safer financial returns via stocks and equities.
However if you love the entrepreneurial journey, love seeing things be summoned from nothingness into something that impacts a huge amount of people, and are willing to loose money along the way, then angel investing may be for you.
With that in mind, what can we learn as angel investors? As I’ve mentioned, there is a lot of luck involved, so you can’t learn much from luck, as you risk over-indexing on something that wasn’t actually the influencing factor. What we can learn however, is from our entrepreneur’s constant iterating and relentless building. We can choose to apply similar concepts in our day jobs or in our own businesses. One of the things I love most about angel investing is that it is almost like having counter factual business scenarios, which helps enrich my thinking around my own businesses and startups. We get to see the impact of decisions in real life, across broad swaths of businesses.
That is how I think about angel investing. 😇