Not Every Qualified Investor Can Be An Angel
By Eric Dobson
It is a romantic idea to want to be an angel…to be a patron of the startup, or as one of our members phrases it, “worshiping at the altar of capitalism.” Every day I hear about how much fun most people believe my job is because of the ability to work with passionate entrepreneurs to turn dreams into reality. And, you know what? It is fun! Most successful people I know say they want to become angel investors. But, not every qualified investor can or should be an Angel. And, I am tired of UNMAKING Angels!
It is no secret that Angel Investors, as an industry, enjoy better than market returns. According to the Kauffman Foundation, the industry average is 2.6x on your money in 3.4 years (individual results will vary widely…and we are about to talk about why!). Out of the 5 – 8 million qualified investors (according to the SEC regulations of $1M in net worth excluding your primary residence or $200,000 in annual income), only approximately 320,000 individuals choose to do so (Angel Capital Association, 2016). That is a NOT a happy number! It amounts to between 4 and 6 % of those qualified, which is well below the “tipping point.” If the returns are so great, why aren’t the rest of the qualified individuals investing in the angel capital industry?
The answer is two-fold. First, angel investing is not easy. It takes work. It takes time. And, it takes dedication, participation, and collaboration. Second, it takes intestinal fortitude to weather the inevitable losses that come, typically, before the wins. Industry numbers on the process are intimidating. As an industry, Angels return capital from 6 out of 10 investments with one to two exiting companies paying for all the loses plus a healthy profit. In this model, 4 – 5 will be a total loss, 3 – 4 will be a modest return or loss, and the last 1 – 2 will be the ones that pay for the entire portfolio. Venture capital numbers are, not surprisingly, very similar. It is daunting to watch a great idea in the hands of a passionate entrepreneur crash and burn….and not just one, three to four of them! And, almost inevitably, the ones that return capital are the last to exit. As they say in the industry, the lemons ripen in two years, but the plums ripen in 4 – 7. So, it is not just one leap of faith. It is a series of leaps of faith in the face of statistically backed failure!
For this reason, the industry recommendation is to make 20 investments over 3 – 5 years to give the best odds of returning 2 – 3 times your capital (Rose, 2014). That sounds simple, but it is deceptively hard. We all want to believe we are smart enough to pick the winners, but that is hubris talking, not financial savvy. So, the first few loses are hard to swallow no matter how sophisticated an investor you are. And, there will always be one that will surprise you that you thought was as sure a bet as can be made. Luckily, that works both ways and one will almost certainly surprise you that you thought was a “walking-dead.”
Despite these recommendations, many new Angels want to stick a toe in the water to test it. I do not recommend this. Because, I believe this is the root of UNMAKING Angels. And, we are really good at it as an industry. The fastest way to lose at angel investing is to make two – three investments and then sit on the sidelines “to see how they perform.” Yet, this is exactly what many first-time angel do. They come in with the best of intentions, make two to three investments, and then decide to see how these first few work before proceeding. They have almost certainly nailed one foot to the track at the beginning of the marathon, and they don’t even know it. The likelihood of one of these three being the big home run is one in 10 if you believe the industry numbers, which are also subject to regional variation. And, they will have to wait up to seven years to find out if they hit the lottery or bought a losing ticket. Because they are not investing, they stop participating, lose interest, and slowly drift away. Finally, without meaningful exits quickly, they throw their hands up in the air and proclaim that angel investing is a bust. Thus, another Angel is UNMADE. It is a very, very common process. No matter how many times you tell someone not to fall into this trap, they do. I can’t describe how tired I am of UNMAKING Angels.
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