Investment Strategy

Creating your Personal Investment Strategy

Doug Konkin’s final words in his interview for this newsletter encapsulates his reasons for becoming an angel investor, “investing is about taking risks, engaging with people, advising others based on your experience, and sometimes winning financially.  It is engaging and personally rewarding; and it is certainly addicting!

There are many compelling reasons for becoming an Angel even though it is a risky asset class! Let’s look at how successful investors build a portfolio that reduces risk and increases their chances of greater returns.

The Wiltbank Report 2007 “Returns to Angel Investors in Groups” is considered some of the most valid research on angel investment returns (as members of a network) and will be referenced throughout this article.)

Wiltbank found the key multipliers that impact returns are; due diligence, experience and participation.  In this article these will be reviewed as well as tolerance level, diversification, time commitment, scalability, expertise and monitoring methods.

1. Your level of tolerance

For new angels setting aside an angel investment, allocation is an important step on the path to writing the first cheque.  Points to consider:

  • It is recommended that 3% – 5% of total net worth is what you should invest in this asset class; for example, a net worth of $ 1M – $2.5 you should consider $55,000 – $137,000.
  • Think about how liquid your net worth is, because it will be moving to non-liquidity.
  • How much risk is in your existing portfolio.
  • How much are you willing to lose and what makes your spouse uncomfortable.

Your allotment of dollars for angel investment along with how much time and energy you can commit, what your exit expectations are and how much you invest in each company will determine the number of companies in your portfolio.  This is impacted by mathematical chances; the more companies in your portfolio the greater the chance of finding that big win.  Christopher Mirabile of Angel Capital Association and Co-Managing Director of Launchpad believes 10[1] should be your minimum target.  In the Wiltbank Study, those portfolios with 6 companies, had 50% of their funds returned, those with 12 investments, 75% reached the 2.6X multiplier.

2. Diversification

A balanced portfolio is often defined as one with a cross section of industry representation.  The challenge is, it necessitates investors going out of their own area of expertise.  This is the value of becoming part of a network and collaborating with peers that have expertise in areas you do not.  In counter to this, having an industry focus creates deeper due diligence and synergies across your investments for network and collaboration.

Diversification also includes your portfolio’s companies estimated time of exit.  The Wiltbank report states that the length of investment time can determine your multiple of returns but also increases risk and enduring longer periods of non-liquidity.

The distribution of the returns multiplier based on duration of investment from the Wiltbank report is:

  • 3 years – 1X
  • 3.3 years – 1X to 5X
  • 4.6 years – 5X to 10X
  • 4.9 years – 10X to 30X
  • 6 years – 30X

The longer the investment time, the greater rate of return AND the higher the rate of failure. You need to consider a balance of early exits and long term commitments that will work for your investment style.

3. Time commitment

Angel Investing is like anything in life, if you want to succeed you need to commit your time, and time is a limited resource. You need to decide how much and how you want to most efficiently use yours.

  • Time spent before you invest – Due Diligence

The Wiltbank report demonstrates the importance of validating the deal prior to writing the cheque.   20 hours was the median spent on due diligence.  Splitting between less time spent than the median and more time spent there was an overall multiple difference of 5.9X for those with high due diligence compared to only 1.1X for those with low due diligence.   It is important to remember these results are directly correlated to time spent on due diligence not quality.

If you want to accomplish a greater than average outcome you must get comfortable with due diligence.  Take time to participate in the process through SCN, even if you are not sure you are going to invest.  Practice, practice, practice and learn from more experienced investors.  As a new member of ACA consider attending their March 22 webinar, Due Diligence – Beyond the Basics.

  • Time spent after you invest – Active versus Passive Investing

Fred Wilson, an angel and blogger for AVC[2] notes if you choose passive investing, it is better to make sure those deals are fairly liquid, so if things don’t go your way you can get out.

Active Investing involves mentoring, coaching, financial monitoring and making connections.  In the Wiltbank research cohort, the investors that interacted with the company a couple of times a month experienced an overall multiple of 3.7X in four years.  The investors that interacted with ventures only a couple of times per year experienced overall multiples of only 1.3X in 3.6 years.

It is hard to scale an “active investing” model when your time is a limited resource.  A mix of passive and active investing may help you diversify and increase the number of investments in your portfolio.

4. Scalability opportunities and risks

Are you looking for quick exits or are you in for the long haul? Scale-ability is all about time.

Are you looking for venture back-able deals or a deal with a hungry acquirer in the market? A common acquisition in the market right now is “Acquihire” which is when big companies acquire small companies for their human resources.  For angel investors, this may restrain your companies’ scale-ability and thus limit your return but speed up your exit.

  • Follow-on Investment

You can get in for less money if you get in on deals early, however it also means that you need to consider follow-on investments.  You need to consider the consequences of follow-on investments as this can limit your diversification, but could support quicker scale-ability.

Do you follow-on or look for other investors?  Wiltbank suggests your returns might be reduced if you follow-on.  In his cohort of investors that did follow-on investment, the multiple is still positive at 1.4X but lower than the 3.6X for those that did not take a follow-on investment.

Series A is still a long way away and you don’t want to cash starve the start-up.  Institutional money always leaves space for follow-on money for start-ups.

  • Venture backing

Doe this help with the scaling?  How fast to grow, how to finance that growth and when to exit will often determine if you want venture involvement.   35% of Wiltbank’s investors took on VC, and this does not appear to increase the multiples significantly, though the investments involving VCs had more extremes; with more failures and more, larger exits.  Angels tended to fail less but have smaller multiples.

5. Industry Expertise

It makes sense to invest within your own area of expertise as that enables deeper dives into due diligence and the creation of stronger networks for your investments.   This may not be ideal for balanced diversified portfolios; Wiltbank found that 50% of investments were not in the investor’s area of expertise, but that angel group investments in the group’s area of expertise had twice as high returns.  The best way to diversify into areas outside your expertise is to be active in your angel network.

6. Monitoring and maintaining

Monitoring can avoid costly mistakes.  Using an Investment Portfolio Management System will help track and analyze; and some systems share with your network of advisors and professionals.  Examples are Seraf, built by Launchpad Venture Group in Boston and AngelSoft (now Gust).   Then there is always Excel spreadsheets.  These tools and spreadsheets help adjust for exits, tax credits if available, and track cash events as they are often spread out and its tough to rely on memory.  Some have alert mechanisms.

In Conclusion

Understanding your allocation of angel investment capital, your risk tolerance, and the time you are willing to commit are the first steps.  Learning from the experts and taking action to diversify by expanding your expertise, determining how to scale your portfolio – balancing exits and managing liquidity and follow-on investments – will help you determine what type of investor you are and help your portfolio succeed.

Stay current; follow industry experts, understand tax implications, estate planning, best practice and emerging trends.   As one presenter on the ACA webinar “Best Practice Series: Angel Portfolio Strategy” [3]noted you must be comfortable with your investment style and portfolio, so stay true to yourself and don’t compare yourself to others.

Most importantly stay up to date on your investments!!!


[1] “Angel 101, A Primer for Angel Investors