Failure™ Magazine

Fool’s Gold?

Debunking the myths of angel investing.

Written by Jason Zasky   Filed under Business

Why is it important to define angel investors?
If you don’t define them you can’t actually tell if they are the same or different than any other group of investors, and you run into problems when trying to compare information from one source to another. For example, some people say you can’t be an angel unless you are an accredited investor [as defined by federal securities law]. Others say there is such a thing as an unaccredited angel. You need to have everyone talking about apples if they are trying to describe an apple, and not have half the people talking about oranges.

How well do angel investments typically perform?
Not very well. The typical angel investor doesn’t get any money back. Less than 0.2 percent of angel-backed companies end in an IPO [Initial Public Offering], and less than 1.5 percent end in an acquisition, so only a very small percentage end in one of the exits you want.

Even if you consider accredited investors, who are on average, the better performing angel investors, and then look at the ones associated with groups—high net worth people investing as part of groups—you find that half of those investors never make any money. In fact, 40 percent of the investments return less money than the capital that goes in, and seven percent of the investments account for 75 percent of all returns. It’s the few phenomenal outcomes that make up for the losses of most.

What do successful angels do differently from typical ones?
One of the things they do is acknowledge distribution of performance. The successful ones realize that they can’t pick the winners with enough certainty, so they invest in 10 or 12 companies, as opposed to just one.

The second thing is that they have incredibly high expectations for each of their investments. So even though most do poorly they make enough on the one that does well to get a decent return. That means having return expectations that are on the order of 30 times the invested capital.

A third thing they do is to pay attention to industries that tend to attract professional investment. Venture capitalists invest in a relatively small number of industries that account for a disproportionate amount of the IPOs and acquisitions by public companies. Most successful angels understand this, so they only invest in those select industries.

A fourth thing is that it can be tempting to make investments passive and not get very involved in companies. But the successful angels do more due diligence and more closely monitor their investments.

Finally, successful angels are scrupulous about structuring deals. They are careful to not over-value companies and they have attorneys draft good contracts.

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