How to Set Up New Angel Investors for Success

Angel investing is risky and it’s hard. You review hundreds of deals and only investing a few. Of those investments, most will lose money. If you manage to do well, you’ll have a couple winners in your portfolio which will drive your portfolio return. While success can seem like a matter of chance, there are a few things you can do to tilt the odds in your favor. Let’s walk through my recommendations that will give you the best chance of success.

Portfolio Construction

By investing in a large enough group of startups, you’re more likely to invest in one of the winners. Using data from a 2007 Wiltbank study and a Monte Carlo analysis, we can look at the probable outcomes for various portfolio sizes. The difference in outcomes is stark; a portfolio with only 6 investments has a 50% probability of not losing money (but not making any either). If you increase your portfolio to 24 investments, there’s a 90% probability of a 2.6x return. That’s a significant difference, based on nothing more than increasing your number of investments.

But why is a diverse portfolio construction so important?

It’s nearly impossible to know which companies will be winners. Some startups will have great traction at an early stage, then run into issues scaling. Other companies will fail because a competitor was able to push them out of the market. Some startups fail due to the larger macroeconomic situation, not necessarily through any fault of their own.
The risks and rewards at the Angel stage are asymmetric. Meaning, you can only lose the amount you’ve invested. but on the upside, you can potentially have a 20x, 30, or 100x return. The majority of companies (67%) will return less than $1 for every $1 invested, but ~7% will have a 10x or greater return. These large returns on a relatively small number of investments is what drives overall portfolio success.

Key Takeaway: You’re better off writing more checks and smaller checks at the angel stage. Diversification is one of the best ways to protect your overall portfolio.

Due Diligence

This is a term that gets thrown around a lot - but what exactly does it mean? Due diligence is the comprehensive appraisal of a business undertaken by a prospective or current investor to establish a companies’ assets and liabilities, as well as evaluate its commercial potential. The process of due diligence helps investors thoroughly understand the business they are considering for investments, including its market potential, financial status, operational aspects, legal standing, and other critical factors.

Why is due diligence so critical?

The importance of due diligence in angel investing can't be overstated. It
gives investors the confidence to make well-informed investment decisions,
reducing the likelihood of falling into pitfalls or getting involved in bad deals. Proper due diligence not only helps to uncover potential risks and challenges but also identifies opportunities and areas for growth.
Thorough due diligence sets the stage for ongoing engagement between investors and entrepreneurs, fostering a stronger relationship and a shared understanding of expectations and responsibilities. When you go through the diligence process, particularly as an angel, you’re looking for deal killers and obvious mistakes. You want to spend time with the management team, educate yourself on their market, and ask common sense questions. You have to identify the key risks, build your investment thesis, and then decide what you need to believe in order to invest.

Key Takeaway: Once your comprehensive due diligence appraisal has wrapped, you can piece together your thesis.

At this stage should be focussed on:

The Team: Are they an A team or a B team?
The Market: Is the market big enough?
Product: Nice to have or need to have?

You’ll never totally eliminate all risk from angel investing, but you can reduce your risk. If you want to learn more ways to reduce your risk, while joining a network of fellow investors, join the Render Capital Angel Network. The Render Capital Angel Network’s focus is on exactly the kind of education that can prepare you to reduce your risk and build you up for a successful portfolio. In our monthly meetings, we go into detail on portfolio construction and the due diligence process, among many other crucial areas of interest.

Join us at our July Angel Network events - July 11th and July 18th. For more information, you can also reach out directly here.