Sunday, July 16, 2017

Things I wish someone had told me before I started angel investing

Back in 2005 I suddenly found myself sitting on a big pile of money after the Google IPO so I did what any young nouveau-riche high-tech dilettante would do: I started angel investing.  I figured it would be more fun to be the beggee than the beggor for a change, and I was right about that.  But I was wrong about just about everything else, and I got a very expensive education as a result.

Now that I am older and wiser (and poorer!) I can look back and see that I did some incredibly stupid things that I could easily have avoided if I'd just gotten myself some proper mentorship.  But I was in LA at the time, and good con men were more plentiful than good mentors.  But it's Sunday morning, I'm up (relatively) early, I don't feel like writing code or complaining about Donald Trump today, so instead I'm going to write the blog post that I wish someone had written for me back in 2005.

The first thing you need to decide is whether you are investing as a hobby or as a serious attempt to make money.  If you're doing it as a hobby you don't really need to worry about much, except to prepare yourself for the likelihood that this could end up being a very expensive hobby.  The absolute minimum to play the game even once is about $5-10k, and if that's all you have then you will almost certainly lose it.  You're more likely to make money by going to Las Vegas and betting on roulette.  If you are investing casually you should be prepared to lose every single penny you put into it without regrets.

If you are investing as a serious attempt to make money then you have a much tougher row to hoe.  Basically, the process goes like this: your early deals will almost certainly not pay off.  You have to approach them as if you are buying an education for yourself.  You will find some awesome-looking deals, ones that you will think are absolutely 100% certain to be the Next Big Thing (NBT), and you will be tempted to buy as big a stake in them as you can afford because you don't want to miss out on the NBT, because NBTs doesn't come along very often.

Don't do it.  The odds that what looks to your inexperienced eyes like an NBT is in fact an NBT are vanishingly small.  There are vastly more good pitches out there than there are good companies.  If it were easy to tell the difference, then Y Combinator — who by now are as good at picking winners as anyone and better than most — would not have to invest in hundreds of companies every year, they would just go straight for the winners.

Here's how it goes: you will (almost certainly) lose money on your early deals, and you will be shocked when this happens.  You will be shocked even if you were intellectually prepared to see your investment fail because the way in which it will fail will almost certainly come as a surprise to you.  You will be amazed at the stupid shit that founders do, the evil shit that competitors do, and the completely random fucked-up shit that markets do (like completely ignore products that are clearly superior in every conceivable way!)  There are a myriad ways to make a company fail, but only two ways to make one succeed.  One of those is to make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition.  That is incredibly hard to do.  (I'll leave figuring out the second one as an exercise.)

So your early deals will fail unless you get incredibly lucky.  Your goal at this point is not to make money, but to learn from the mistakes that you and your investees will inevitably make.  Starting a company is not a linear process.  There is no recipe for success.  It's a long hard slog of never-ending problem solving, crisis management, and plain-old shit work.  Some people just have the knack for getting through this, but most don't.  Your goal is to develop a sense for how to recognize the people who have the knack, and distinguish them from the ones who are good at giving the impression that they have the knack, but really don't.  This is hard because being a good con man is much easier than being a good entrepreneur.  And by no means are these two talents mutually exclusive.

This early stage will last several years, and if you're not prepared to act on those kinds of time scales then you'd better find yourself a different path in life.  During that time you should be taking meetings constantly.  Why?  Because the more people you meet, the more data points you will gather about what success looks like early-on (and, more importantly, what failure looks like early on), and the more likely you are to find the needle in the haystack.

Actually, the needle-in-the-haystack is not quite the right metaphor.  There is a small cadre of people who actually have what it takes to successfully build an NBT, and experienced investors are pretty good at recognizing them.  Because of this, they don't have trouble raising money.  As I mentioned earlier, one of the reasons people get into angel investing is because they think it's more fun to be the beggee than the beggor.  But the cool kids don't beg.  The cool kids — the ones who really know what they're doing and have the best chances of succeeding — decide who they allow to invest in their companies.  And they want investors who have been around the block, who know what they are doing, who have a thick rolodex of potentially useful contacts, and most importantly, deep enough pockets to do follow-on investments, and thick enough hides not to complain if things go south.

If you want to make money angel investing, you really have to treat it as a full time job, not because it makes you more likely to pick the winners, but because it makes it more likely that the winners will pick you.

If you're not ready for that, you will be much better off financially buying index funds.

Good luck.


Jazz said...

Thank you for your incite! Recently, I've been looking into the concept of investing; reading the Wallstreet Journal, countless YouTube videos, and online news stories, but none of them were this honest.

meitnerium said...

Your article is really interesting. I would appreciate knowing, in your experience, what has been the most frequent reason for startup failure?

Ron said...

@ meitnerium:

There is no "most frequent reason." The world is incredibly creative in coming up with new ways for companies to fail. Just when I think I've seen it all, someone always comes along and surprises me.

I could (and maybe I should) write a book about all the different ways I've seen companies fail.

vasilakisfil said...

There is one problem though. Angel investors that are "learning" the process are really bad for the companies that they are learning from. Basically these meetings that you are talking about, is wasted time for founders. Even worse, when such angel investors are influencing the development process (because hey! Cool company A does that, we should it as well) then developers have problems out of nowhere from people who control the money and influence the company yet don't have the necessary experience to influence on the right way.

Ron said...


Green angels are only a problem if they don't recognize they are green. Experienced founders should want to cultivate new investment talent no less than experienced investors should want to cultivate new founder talent. A new investor who said, "I have no idea what I'm doing, but I want to write you a (small) check (which I'm absolutely prepared to lose) in exchange for letting me hang out and learn the ropes" should find a warm welcome.

Dave said...

"experienced investors are pretty good at spotting them" [them = successful entrepreneurs]

no, this is demonstrably false. as you mention with YC, if investors really knew what they were doing, then their portfolio size would be n<5-10, rather than n>20-40 (or for early-stage, n>50-100).

even the best angel and VC investors get it "right" (ie, 10X or better outcomes) perhaps only 10-20% of the time. this is especially true if you are investing at early stages before the company has substantial revenue (or even tougher, pre-product). even at Series B/C or later when companies have real revenue (>$10-20M) most investments don't generate substantial returns >5X.

even experienced investors get it wrong most of the time. if they are lucky, their outliers will return a greater multiple than the small % of time they occur. that is to say, if i get a 20X return 10% of the time, or a 50X return 5% of the time, or a 100X return 2% of the time, then i win the game.

the advice i wish someone had told me when i started angel investing (~15 years ago) is simply this:

try and get great dealflow, ideally by investing alongside other experienced entrepreneurs... and, invest in a LOT of startups (at least 20, ideally more like 50-100). then wait ten years.


meitnerium said...

If the suggestion is to invest in ~50 companies how much is recommended per company, is ~$50,000 about right? That would come to $2.5 million for a portfolio of 50 companies. That's discouraging for first-time investors who may not have that amount of money to begin with.

Michael Palmer said...

@meitnerium, you can sometimes invest solo with $25k but if you want to be able to negotiate you will need to get several friends together and put in $100k or sometimes double that.

If you join an angel group, that group will have more combined capital and you can probably go in with as low as $5k per investment. You will learn a lot and meet a lot of people your first few years in an organized group. In any organized group there are much-more- and much-less-active members. If you are active, you can befriend the other active angels. With a group you can find people who are expert in various useful domains - either technical domains, or finance, and you can complement each other.

I agree partly with the author that there is a "cool kid" class of entrepreneurs / investors, but the cool kid companies tend to be expensive and there are definitely lots of genius folks who aren't extroverted enough to be "cool", but they can make good strategic decisions and knock out solid work. I have had decent luck making great technical contacts and finding solid companies that aren't quite at the Ashton Kutcher level of cool, but very solid technically and business-wise.

Finally, start with smaller dollar amounts until you figure out what you are doing... especially if you are solo... In fact I wouldn't advise investing solo initially, like going to demo days and just spreading money around. I would find some experienced friends or join a group. There is a ton that you (or your group) has to understand - the technical domains you are investing in, the kinds of markets you are investing in, all the terms and conventions around financing, a lot of legal stuff, etc.

Another way to start at the very beginning is to invest through syndicates on AngelList, but you won't learn so much that way. You paying carry to have the syndicate lead understand everything, and you won't be actively involved. But you could do a couple investments that way to try it.

Droconnel22 said...

Great article, thank you!

The last paragraph is one that hits particularly close to my own experience. Raising money isn't the issue, but raising good quality relationships with depth and how they believe in you despite the challenge.

Kissing frogs is part of the game and most times you are the frog, but if you keep at it, keep reinventing, and hold your ground you might surprise yourself.

Don't take as what i wrote as advice, merely the agreed observations of a fellow traveler.

Ron said...


>> "experienced investors are pretty good at spotting them" [them = successful entrepreneurs]

> no, this is demonstrably false.

It's not "demonstrably false" because I didn't define what I meant by "pretty good". At worst, it's a vacuous claim.

Experienced investors reject bad deals with odds better than chance, which improves their odds of finding the good deal. I put a lot of money into deals which, in retrospect, I could easily have seen ahead of time were never going to make it if I'd known what to look for.

> @meitnerium

$50k is a little on the high side, but only a little. I've done deals with as little as $5k, but only as part of a syndicate (Michael Palmer's suggestion of joining/forming an investment group is a really good idea!) Personally, I would not start investing seriously again unless I had a minimum of $1M to work with. I'd use half of it to do 10-15 deals at $10-25k and save the other half for 2-3 follow-ons in the low six figures for the ones that looked like they were going to succeed. But that's an absolute minimum. Ideally I'd like to have $5-10M to be a real player.

Unknown said...

So what kind of things did you invest in?

roger dust said...

Did anyone figure out the second kind of successful companies ?

Unknown said...

what are your thoughts on equity crowdfunding platforms like SeedInvest? they generally require a min. investment of $500 or $1K. Is it worth it for a small time angel to invest $1K in 10 different companies or $500 in 20 different companies?

Reed M Benet said...

Thanks for this post, Ron. I'd be curious about your thoughts on these AIHADITF (i.e. admittedly I have a dog in this fight) musings...

I'm a second $500K of funds seeking entrepreneur out in TNRNMWNMNH (i.e. take no risk no matter what no matter no how) Detroit with, my for the 23.3 million of my fellow military vets, our up to $424-721K each of no-money-down VA Loans home buying power, and correcting and leveraging the fact that up to 99.85% have no clue we can use this to buy and be resident landlords in up to entire renewed or new communities anchoring duplexes, triplexes, and quadplexes.

And with a $10-18 Trillion (not a typo) TAM, I fit your address a big unmet need criterion?

It looks to me, though, that angels and even VCs are lock stepping Lean Startup on small and derivative or me-too ideas...?

I only see Peter Thiel in Zero to One challenging Lean Startup (he says this is a hangover from the Web 1.0 dot-bomb era), YC type portfolio of lots of small investments (he says go few and fund big), you need to invest in big opportunities because risks are so high in all startups that the few that work out must make the portfolio, etc.

Actually one of my bucket lists was at the recent Silicon Valley Vet(eran)Con(ference) asking during Q&A Steve Blank how Lean Startup tracks against achieving Unicorn-ness and he said he didn't know. And this is The Godfather of Lean Startup and I think he only feeds into above said TNRNMWNMNH, particularly in the Midwest!

Being an ABD (is all but dissertation) PhD in Engineering, so I was once decent in statistics, and given all the variants of opportunities and outcomes that you cite, particularly that the better mousetrap often doesn't win, what about if it's all randomness and we're all kidding ourselves? And thus maybe you weren't on the mistaken path rather you just didn't do enough? That syndicates and angel groups and accelerators and incubators are "a camel is an elephant designed by committee" homogenizers into group think mediocre?

It's hard to set up a variability controlled trial, but seems to me that 400 plus samples drawn randomly always is the case.

So how about you and your angel investing compatriots fund, mentor, and demo day 400 randomly selected startups out of YC's reject pile and then let's compare?

Thanks for your thoughts!

Reed M. Benet

Francesco Giartosio said...
This comment has been removed by the author.
Francesco Giartosio said...

Thanks Ron, brilliant post! I mostly agree, but not fully. Yes, the cool kids don't beg, they can (to some extent) pick their investors; but they will still be glad to take money from a newbie angel, what they will avoid are toxic angels, that waste your time and peace of mind.
Plus, you still won't be able to understand if those who are picking you are the winners or more con men.

If I were an angel, I think I'd spend my time in startupers newsgroups and events, putting myself in their shoes as much as I can, I'm surprised that so few angels do that. But I'm a startuper instead ...

Maximilian Winter said...

I second that - You should