As with any other investment Assets Class in order to build a high performing portfolio, investors will be more effective following some Golden Rules to ensure there is an acceptable level of risk management. Although the Angel Investing Assets Class does not have a robust base of historical data and not too many investment models and tested algorithms developed as we see in other assets classes, there is enough data collected from active angel investors to provide some kind of Critical Guidelines to serve as safeguards to protect the investors from making simple mistakes that can be costly at the end.
Here they are:
- Do not invest more than what you are willing to lose! – The common sentiment is to invest no more than 10% (15% if you are an aggressive investor) of your overall investment portfolio. Invest only the capital you can live without and if lost, will not have a dramatic impact on your financial stability and lifestyle.
- Use capital you can live without – Venture and early-stage investments are not liquid investments, such as stocks and bonds that have a high level of liquidity. In most deals, you need to know you will “park” this capital for 5-6 years and in some deals even longer. You will not be able, or it will be a lengthy process to liquidate your investment at the time of need.
- Diversifying your investments – Make small investments in larger groups of companies instead of large investments in smaller groups of companies. The three pillars of diversification of a venture portfolio; the number of deals, stage of deal, and size of the deal in order to build a balanced portfolio that will have a high probability of higher exit value.
- Join an Angel Fund or a Syndication – It is much more effective, and has a higher rate of return to join a fund or a group or both to mitigate your risk. By being a part of a group of investors, such as a fund or syndication an individual will have access to the “Crowdwisdom” and voice of reason that in most cases offers a higher value-added.
- Invest as a legal entity – It is commonly ignored that it is highly recommended to invest as a legal entity or a trust, if such exist, and not as an individual. This is because of the risk in venture deals and the fact that in the event that there is a legal action against the company, attorneys will go after all stakeholders, especially investors that appear as the deeper pocket, having another layer of legal sheld, make it more difficult.
- Adapt an investment discipline – As we say, adapt the opportunity to your process and not the process of the opportunity. Developing a screening, qualification and a repeatable due diligence process is key to increase the quality of your deals and the performance of your investment portfolio.
- Create your preferred risk profile – Define your comfort zone. What is your number – i.e the total amount of available capital you are willing to risk. You know or at least should know yourself and what is your natural risk tolerance if you are a risk-taker or risk-averse. It is important given you will be in a deal on average of 5 plus years that it will not be a constant source of stress and concerns. After all, you want to enjoy it while making money.
- Separate your personal preferences and your emotions from the deal – You need to look at each deal on its own merits. Personal preferences and emotions tend to have biases and can cloud one’s judgment in selecting the right opportunity, and it can be more challenging when doing it on your own.
- Build and establish your advisory team – It is highly important to build and establish your network of advisors that will help you cover all of the areas of business operations to help you make sound decisions. Business success is more than just the financial aspects, there are many other moving parts and you need to ensure you have readily available access to other professionals with a variety of business expertise and competencies that you can trust.
- Define your level of involvement – In order to be a value-add to your portfolio of companies, you will need to define your level of involvement that will fit your personality and lifestyle. Whether you are an active or passive investor, it establishes a benchmark of the expectations from the start. Some companies welcome active investors and others seek passive investors. It is a personal decision based on one’s needs, wants, and desires. You need to make sure you choose opportunities that will fit your choice, so you will not be dragged into undesirable and uncomfortable situations.
Just a note, Angel and Venture investing comes with certain levels of risk, more than the traditional conservative investment strategies, yet the risk-rewards ratios are much higher than all other Asset Classes. It is not for everyone, although there is a romantic notion that you can hit the jackpot and make lots of money, in most cases it is the opposite and if it happened it is probably somewhere in the 1000:1 ratio.
Investors who adopt a set of guiding principles can reduce the risk to a manageable level and increase the success rate by 10X.
Note: This document was prepared with the information required from the following Data Sources:
Wikipedia, Investopedia, Seraf, TechCrunch, Forester, Ann Arbor Spark, Michigan Angels Community, ACA, MVCA