For many people like me, angel investing is akin to being a pirate. You sail the vast seas in search of the Urca de Lima of startups. Every encounter with the navy ship (the WeWork of our time) can cause you your life,get decapitated, or your team turns against you and leave on a deserted island with just a single bottle of rum. But every once in a while some pirate (which could be you) hit that cargo ship with gold bullion. And you’re set for life. Pirates are strong, courageous, smart, and they always have beautiful women around them. This is how I viewed angel investors. Until recently.
Angel investor as romantic pirate
Let’s first start with the image of a pirate. The romantic image of the angel investor is tied very strongly to the image of biggest startups: “I was one of the first investors in Uber, Lyft, AirBnB, Box, Dropbox, and 50 other similarly large companies” is the phrase I often hear when reading or listening interviews about angel investment. PG, Naval, Jason Calacanis, Tim Ferriss are just a handful of names that are frequently asociated with the some of the most successful startups. But just like the startup story I was sold about 10 years ago, I got hooked with the incredible success of these people and got caught in the survivorship bias.
You rarely see the failures, but you often hear loud and clear about their successes which creates a distorted picture that it is easy and extremely profitable. The truth is, very few survive, and just a fraction of them makes it to the big league.
It would be wrong to compare angel investment to the lottery, but there are some similarities. There’s a great story from NY Times about a person who figured out how to win big. It’s a calculable bet: sometimes the price for all of the lottery tickets is smaller than the jackpot which would make this enterprise profitable. To some degree it is quite similar to angel investing: you need to invest into a lot of startups to pick that one lottery ticket that would bring you the jackpot. The problem here is who has the guts to lose 100K-1M in the span of 5-20 years (because your startup pool might not be as big as in Silicon Valley) until you finally get the gamble to pay off.
Most of the average people like you and I can spare €50-1000/month, and that money is what you use for travel, pub crawls, buying that expensive toy you always wanted, or fixing a leak in the roof of your house. Now imagine throwing all of that in the waste every month.
Crowdinvesting platforms pop up every month. During the last bitcoin bubble ICOs were raising millions upon millions of virtual money only to later evaporate. While platforms like Funderbeam or AngelList are unlikely to have a completely fraudulent company raise money, there lies another problem: you are unlikely to have a say in the company strategy or even know about their plans. Helping the company that you invested in would likely end up being some manual labour like sharing their social media posts among friends and buying their produce at a slightly discounted price. You would earn more by doing the same on Fiverr and investing that money into an index fund rather than betting on a startup.
Unless you’re the lead investor (which means you’re an actual angel investor), you’re unlikely to influence the strategy of the company, not to mention the financial reports that you’ll likely not receive or be the last one to get them. This leads to a form of principal-agent problem. Big investors face it too, but they have more leverage over the company management than everyone else.
As an investor you are likely to hit it big with a founder who has a history of successes or failures. Yes, people who have failed multiple times and had the courage to continue are very likely to eventually succeed. Such founders are the most precious asset in your investment portfolio. They will run experiments, sometimes very costly, sometimes less so, and your job is to keep funding them until one succeeds and propells you to the retirement at 30 (or more likely at your 65-70 and funded by the government, not your investment).
Failing is hard. Failing multiple times in a row is even harder. In my roughly 10-year startup life I had a lot of failures, big and small. As investor you will be failing just like me, multiple times in a row. And if you don’t have a lot of spare cash you can live without, giving that money for someone to experiment and fail becomes ever harder with each subsequent loss. Would you give part of your salary to a drug addict who tells you they will spend it on rehab only to later find out they bought another dose? And that same thing happened last month. And 5 months ago. Of course it might eventually work out. Or not.
The imposter syndrome
Unless you’re a well-connected person with multiple successful exits and a good chunk of cash at hand, why should a startup prefer to take your €1-2K over a more experience investor or a syndicate comprised of business people with deeper pockets? Well, none.
Having spent 15+ years in the IT this is the domain I have the most experience in. These days however, most of the startup co-founders I meet are just like me: software engineers. So what can I advice a person with similar experience that 10 minutes of web searching cannot? Personally I do have some useful experience in other connected domains, but is that enough?
Finding companies on a regular stock exchange is easy - you just open the list and pick a business from there. Getting startup to invest to via crowd-invest platform is easy too. You can even buy shares of well-known private companies via services like SharesPost: SpaceX, AirBnB, DJI, and others. But we’re talking about angel investing here, ie. very early-stage investing at the stage of a prototype or the first clients. And to have a lineup of founders to invest to you need to be extremely well-connected, love to socialize and party. Yuri Milner of DST Capital constantly organizes parties in his Silicon Valley mansion in order to meet or hear about new promising companies and founders. When you have a constant flow of such information, it becomes easier to pick startups that have more potential to succeed. An average Joe is unlikely to devote oneself to such a life. I personally do occasionally meet new founders, but 1 or 2 people per month is not enough to build a sizeable portfolio over 5-10 years.
The return on investment
The selling point of many investment platforms is they not only allow you to invest in private companies but many also have internal marketplaces where you can trade your shares or tokens in order to get the liquidity. This means that if you’re in need of cash, you can just sell your stock at profit or loss, but get yourself out fairly quickly. Most of the investment deals though happen outside such platforms, and your capital is stuck within the company for the next 5-15 years. Moreover, oftentimes when you invest you might get the preferred stock (shares with extra rights like getting your money back first in a sale).
Given the option to invest in a company now and forget it for the foreseeable (or forever) future or spending that money on yourself, your family, or even philantropy, what would you choose? For me the answer is not so obvious, but still in the majority of cases I would pick the latter.
All of the above applies to an average Joe, ie myself, a person with the average salary who has a family, a mortgage, wants to travel and enjoy life. This essay is also an attempt at explaining myself given the resources and time I have, why I shouldn’t do angel investing for the sake of being the cool kid who invested in this or that company.