Yes, some angel investments will actually implode & go to zero. Here are five lessons learned from one such investment.
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It has been about three years since I revealed some early details about my angel investing efforts. By August 2019, I had developed a goal of 20 investments and exits by 2030 and revealed my first two angel investments.
So how am I doing so far? That question is especially timely for the recent Wall Street correction, rising interest rates and sky-high inflation. In the venture capital world, investors are calling on their portfolio companies to conserve cash and build a faster path to profitability.
How Angel Investing Has Evolved: 2019 to 2022
Meanwhile, the conversation has evolved into the angel capital market as well. A year-by-year summary:
- 2019: Angels will typically ask startups how quickly they can scale monthly recurring revenue (MRR) and annual recurring revenue (ARR) and what is the overall exit strategy. Smart angels like Gerwai Todd, a close friend of mine, frequently ask about cash burn rates and paths to profitability. But Gerwai was a rare voice of reason in a “growth-at-all-costs” market.
- 2020: During the early days of COVID-19, angels would ask about a startup’s dependence on in-office equipment, services and employees, and the startup’s ability to pivot hard toward work-from-anywhere. But very quickly, it became clear that the cloud and mobile infrastructure – and the software that rides on it – would largely keep the economy going. Oh, and everybody had to re-think security.
- 2021: The whispers started. Valuations were getting out of hand. Some angels were privately thinking about saying no to more deals – anticipating some sort of cool-off period as we began to head into 2022.
- 2022: The back room whispers have turned into front-room conversations. Angels are not demanding an immediate path to profitability. But they’re looking far more closely at a deal multiples, burn rates, and the financial math required to keep a business going from seed to Series A, Series B and beyond.
My Angel Investor Journey: The Summary
So what does all that mean for my own angel investment journey? Here’s a scorecard recap:
- Goal 1 – Define the Journey: As you will recall, I wanted to complete 20 investments and exits by 2030.
- Goal 2 – Decide on the Math: After reading books like Angel: How to Invest in Technology Startups and Speaking at length with my wife, we decided that we could potentially – and consistently – risk up to 5% of our net worth on angel investing. Divide that across 20 startups, and no single angel investment would represent more than 0.25% – a quarter of a percent – of our net worth.
- Goal 3 – Build a Network: Through lots of conversations, meetings and luck, I started to talk more often with peer angels like Gerwai Todd, Kevin Blake and Lloyd Wolf. At the same time, I do invest in organizations like Florida Funders, Angel List and Propel (x).
- Goal 4 – Open My Wallet (Responsibly): Through the efforts above, the deal flow started to come my way. During a typical weekend, I now scan through about a dozen investment opportunities that hit my inbox. I discuss those opportunities with a group that we’ve come to call Channel Angels. Then I decided to potentially place my bets – often working with Kevin and Gerwai, in particular. The math? I suspect we will invest in one company for every 50 “opportunities” that come our way.
- Goal 5 – Always Engage Trusted Advisors: Here again, I find myself brainstorming and bouncing off of deal opportunities with Gerwai Todd, Kevin Blake and Lloyd Wolf.
Of the roughly 15 angel investments so far:
- 14 are still in business;
- none had an exit (so far);
- Most remain in healthy growth mode – though some will need to raise more money (Series B or C) in 2022 or 2023;
- Perhaps one of the 15 has a reasonable chance at unicorn – exceeding $ 1 billion in annual revenues if multiple stars align; and
- one has gone completely out of business.
That One Total Loss (So Far): What I Learned From 100% Failure
Early in Q2 of 2022, I learned that one of my angel investments was set to implode and essentially shutter. But what did I actually do learn About experiencing a total loss in one investment?
- Practice the Rule of 20: First, financial diversity is your friend. Imagine if you had $ 10,000 evenly spread across 20 stocks. That ‘s $ 500 per stock. Then, one of those companies goes completely bust. So, you’re out of $ 500. But mentally – since you set a budget and built a long-term strategy – you know 95% of your investments are still in the game. Basically, I learned that I remain very comfortable with my original investment thesis – which involves identifying 20 investments (and potential exits) by 2030.
- Study Burn Rates. Then Study Them Again: The investment that went to zero had a huge burn rate and highly paid executives. If I had bounced off the opportunity of Gerwai Todd, I’m sure he would have told me to avoid the deal because of the burn rate. Alas, I didn’t take that step. Why? Because of a problem outlined below in item 3.
- Ignore the FOMO – Fear of Missing Out: Some deal pitches have tight deadlines. “Put your money in this week, or lose the opportunity forever.” In this case, I certainly suffered from FOMO. In stark contrast, Warren Buffett famously “waits for his pitch” – passing on a deal after being dealt with until he spots just the right opportunity. Buffett generally does not suffer from FOMO. That ‘sa trait I’m trying to emulate.
- Nevertheless, Step Outside Your Comfort Zone (A Bit): The failed investment was in the FinTech market. I’m not a financial services expert. But the investment at least inspired me to brush up on the FinTech market and topic. I was a loser on this deal. But I don’t regret stepping outside of my comfort zone – within reason.
- Recalibrate Your Goals: As your overall angel investment portfolio grows or evolves, it is important to recalibrate goals – perhaps on a quarterly basis or so. My recalibration? Maybe it’s time to invest in 25 total companies, rather than 20. In some ways, that means more risk. But in other ways, that means less risk because I’m essentially spreading That risk across more companies.
All that said, I’m enjoying the journey. Even if it means suffering the occasional total loss. PS: Of the angels I mentioned in this article, I was the only one who did a special deal that delivered a complete loss.