How to start angel investing in startups?

Investing in startups is risky!  In fact, it is considered one of the riskiest asset classes.  Odds are against you if you are betting on early-stage startups.  However, venture capital has come to be a ‘must-have’ within one’s investment portfolio. In this feature, I will share what approach you can take towards startup investing, asset allocation for startups, building your portfolio based on your strengths, and more.

 

Let’s Start with WHY – Why invest in startups?

This is an easy one – startup investments – if you get them right will give you incredible returns. What do I mean by incredible returns? Well, the expected gross IRR for investing in early-stage startups is between 20% – 30%. As an extreme example, Peter Thiel’s initial investment in Facebook increased in value by over 2300X prior to IPO.
Another reason why many ‘angels’ invest in startups is to contribute to the cause or the journey of building something exceptional. Maybe a business that the angel herself/himself can’t build now but wants to contribute through capital, network, and guidance (in exchange for equity). 
Some clarifications here…
What I mean by ‘early-stage startups’
Early-stage startups are recently formed companies that have revenues less than $500k, and looking to grow rapidly (15+% month over month). However, many venture capital firms invest in late-stage companies with valuations over $100mn. Example – Softbank investing in Unacademy at $1.5Bn valuation or the famous WeWork example.
Timeline & Liquidity
Startup investments are highly illiquid, unlike fixed deposits or stock market investments where you can sell and get the money in your bank within a few days. If you are investing in startups, expect it to be for the long term (3-10 years), with no/little liquidity. 
Will you definitely get your money back?
No. Invest in startups only if you can afford to lose the money and that won’t materially affect your financial sustainability. One of the most respected stock market investors recently told me – “Startup investment is a get-rich-quick scheme, and I am happy if I can get 12% annual returns on my investments”.
How much should you invest in startups?
Roughly 5% of your portfolio could be invested in startups. However, ‘it depends’ on many factors such as your risk appetite, current asset allocation, and most importantly your wealth growth plan.
 
OK! Say you’ve decided to invest in startups (with your eyes open), now what?
  • Decide how much you plan to invest in startups each year because it’s a long term game. You are likely to spend the first year learning the game to refine it over the next few years.
  • Based on my calculations, if one invests in roughly 10-11 startups per year for three years then it’s possible to build a decent portfolio of startups that gets you returns and builds access to future deals.
 

Where do you start?

It’s easy and pretty straightforward to invest in startups through platforms like AngelList. You can explore various angel network groups such as 500Startups, OurCrowd, India Angel Network (IAN), TiE Boston, Boston Harbor Angels, among many many others.
Find a person in your network (who’s judgment you trust), and learn about her/his startup investment approach and experience – including portfolio and returns. What you are looking for is access to the best deals.
It’s a numbers game – roughly 450 startups received angel investments in India last year. That’s less than 1% of total startups in India. If you further filter for subsequent investment rounds, you end up with less than 100 startups who’ve made it to the point where you – the angel investor – would get your returns. 
AngelList has made it really easy to identify the top investors (or syndicate leads) who could help you build your portfolio. For example, you could take a look at Better Capital’s portfolio and if it is something that you like and know, you can join the syndicate to invest in the startups that Vaibhav (syndicate lead) identifies.
Alternatively, you could join as a limited partner in a venture capital fund, however, this means you need to allocate a higher amount towards the fund. The fund manager will then invest it in ~ 20-30 startups in the first 2-4 years of  7-10 year lifecycle.
In both these cases, you would pay some version of the 2-20 model to the lead investor/fund manager (unless you source the deal yourself to invest in the startup).
There’s no one way to succeed – so do some research, talk to a few people who’ve made money investing in this asset class, and then ask to join in. 
 

How much should you invest per startup?

I learned this the hard way. You want to be consistent on the amount since it is next to impossible to know which of your startup investments is going to work. So I recommend investing the same amount per startup.
At the seed stage, I suggest $10K or INR 5 Lacs and in subsequent rounds about $30K or INR 15-20 lacs per startup. If you need to invest in 10-11 startups a year, you also need to diversify across (a) stage and (b) geography. For example, in the first year, you could focus on the Indian market with 7 startups at the seed stage and 3-4 in Series A/B stages. Then in the second year, you can diversify into the US or European markets. 
Whatever the case may be, you must build an investment theme. Essentially, the theme could be sector and/or stage and/or geography-specific. Ideally, you should start with sectors where you have worked and have domain knowledge and/or network about what works and doesn’t to evaluate the startup investment.  
 
Ok so you may ask, when and what will you get from your startup investments?
This is where it gets tricky. Some of the best startups will take off and give incredible returns in under 2 years whereas most may linger on for years (to eventually make you write-off your investment). Some of the top investors get 1 out of 10 startups that take off and give multifold returns (10+ X), while 2-3 will give around 2X and others will be a write-off. Failures/write-offs are likely to come earlier than the wins/successes, making this a testing experience for many investors.
Legal and Taxation in your country
Make sure you are aware of the regulations and taxation on investing in startups in your country.
Happy investing and I look forward to hearing about your experience.

 

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About the Author
I am curious about startups, investments, and development.

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