War stories. People love recounting the one time they caught a big fish, not the many futile hours they spent waiting for a bite. Investors love to recap the successful exchange traded investments they did, and tend to forget the unsuccessful ones. Angel investing is no different.
Looking at the venture capital industry as a whole, we know for a fact that the venture capital industry is performing poorly (see previous posts here and here). Cambridge Associates says that only about 20 firms – or 3 percent of all venture capital firms – generate 95 percent of the industry’s returns. Further more, the composition of the top 3 percent doesn’t really change.
The similar pattern is found in the angel investment corner of the venture capital field. Roughly speaking, the best estimate of overall angel investor returns from this data is 2.5 times their investment, though in any one investment the odds of a positive return are less than 50 percent. Or worse. Ron Conway’s second angel fund, for example, which had the good fortune to invest in Google (a 400x cost winner), just broke even close to a 0 percent IRR! Unfortunately, many angel investors do not appreciate this view and tend to neglect that the typical return for angels must be atrocious. Most people who expect to make money as angel investors are fooling themselves.
Angel investment is a profession in itself – with it’s own processes, experiences, ecosystem, etc. Although previous corporate or entrepreneurial success is, indeed, relevant this does not in itself provide the investing skill set, which is completely unrelated to being a good leader and strategist.
So, unless you are so smart that these bare facts would actually keep you from trying, here’s what you should seriously consider as a minimum going forward as an angel investor:
Understand the basic differences between being a good investor vs. a good corporate or entrepreneurial leader.
Learn how your skills will add value to an angel or seed investment ecosystem – and use them as such, because: Those who do succeed have proprietary knowledge of the characteristics of winning companies. Over the years, the knowledge of what it takes to succeed is passed down from one to another and becomes part of an investment organisations’ institutional memory. The premier venture capital firms, for example, know the best investments have high technical risk and low market risk (market risk causes companies to fail).
Take a portfolio approach. Whenever you invest in a risky asset class like startups you need to have a portfolio, because the law of small numbers will likely lead to a complete loss. Hence, build a portfolio of at least 15 or – even better 50 – companies.