How to Become an Angel Investor

Intro

Angel investing – the buzzword of the 00s and a possibility for you to get involved into a new exciting company without building it from scratch.

In one sentence: Got extra income? Invest smart into a startup yet unknown and choose a role of a passive stakeholder and observer or an active mentor.

You are probably wondering: Is angel investing for me?

If you have a proven record or running and building successful companies and ready to help a new business succeed, rather than reaping an immediate huge profit from the investment. Typically, you can seek the return of investment in 3-8+ years.

Here are four convincing examples to give you some food for thought:

Peter Thiel is mostly known as one of PayPal co-founders, yet he was also the first one to make a $500,000 angel investment in Facebook, now worth over $200 billion.

Chris Sacca – now ranked as Forbes 3rd Smartest Tech Investor in 2015, made his first angel investment of $25,000 in the first round of Twitter. The company is now valued at over $30 billion.

Jim Goetz was the sole investor in WhatsApp and gathered over $60 million or so over three rounds of investment to receive over $21.8 billion in cash and stock after Facebook has acquired the app in October 2014.

Jason Calacanis was the first one to spot and invest into Uber. His $500,000 check resulted into a major share stake at a company now worth over $40 billion.

How can I become an angel investor?

The process is simple, really. In this guide we broke down the core stages for you into bite-sized actionable steps to take if you feel ready to co-invest in the next Lyft.

Let’s get straight to business.

1. Determine how much money you are willing to invest

There are two options how you can walk the walk of angel investing – by going solo, which obviously requires larger financial asserts to invest and higher risks involved; or team up with like-minded entrepreneurs to syndicate deals, meaning investing on the same terms with one "lead" investor who tackles the negotiation process with the startup.

Alternatively, the startup fudges together a syndicate of investors who approached them independently. In any case, most likely you won’t be the only investor in the company, especially if the company plans to raise investments in a few seed rounds.

Let’s talk raw numbers.

There are two figures you should care about:

a) how much money you're putting in

b) the valuation of the company, which determines how much stock you get

Here’s an example:

If you invest $50.000 into a company at a pre-money valuation of $1 million, then the post-money valuation is $1.05 million, and you will get 0.5/1.05, or 4.76% of the company's stock.

When the company raises extra funds, the new investor will cut a chunk of the company away from all the current shareholders, just as you did. If during the next investment round they sell 10% of the company to a new investor, your 4.76% will be reduced to 4.28% respectively.

That’s not something you should worry about at the first place. You are protected from mistreatment in the next rounds as you are in the same boat with the founders. Doubtful, they will dilute you without diluting themselves as well.

Another wise move – have special provisions in the contract that allow you to contribute to future rounds and maintain your percentage.

However, here’s the deal: each round of investment leaves you with a smaller share of a more valuable company. If you are left with just .5% during the final round before IPO, you are pretty lucky as your $50.000 just turned into $5 million.

So, how much money should you invest?

Numbers vary drastically. The bottom line for angel investment is 5-10% of the total or $10,000, whichever is greater.

A standard angel round these days might be $150,000 raised from 5 people. Yet if you are willing to invest more – the decision’s up to you. All you need is to learn to identify potentially profitable companies. That’s exactly what we are going to talk about next.

Valuations don't vary as much. Typically, for angel rounds it's rare to see a valuation less than half a million or higher than 4 or 5 million. Everything above 4 million is starting to be venture capitals territory.

Last, but definitely not least – as you are investing on early stages you face the highest risks, yet the potential profit you can receive is the highest as well.

Determine the markets you are interested in

One of the best ways to reduce potential investment risk is to understand the market that startup operates in and preferably have previous experience in working within the domain. This will provide you with a better sense when projecting the potential success of the venture.

Second point to consider: the market potential. Does the problem the company plans to solve cause their customer’s great pain? Is the niche crowded? Is it new? What are the perspectives for development and expansion?

Third: don’t underestimate passion. The most successful angel investors are those who share the same drive and are equally excited about the product as the co-founders.

Last, but not least, decide upon the locations you are ready to work with. Domestic only or international? Your local area or you are willing to travel across the border? Remember, you’ll have to hold a series of personal meetings before closing the deal and might like to get actively involved in the company, meaning extra time and rising travel costs in case you are ready to pursue a company outside your home base.

Craft the ideal company profile you’d like to invest to

As Paul Graham brilliantly puts it: “As an angel, you have to pick startups before they've got a hit—either because they've made something great but users don't realize it yet”.

Not all starups were created equal. Just too often glossy statrups attracting massive amount of investments fail. While those, who didn’t seem all so appealing during the early stages, hit the users soft spot and go mainstream.

How to be a good angel investor?

It all comes to being a good judge of potential.

Let’s talk about horses. Yes, you read it right - horses.

Ponies and unicorns in particular.

In 2013 Aileen Lee from Cowboy Ventures introduced a peculiar term to define over $1 billion worth companies that started with private investment. Facebook was first to be labeled as “super-unicorn” (worth >$100 billion) and San Francisco was named as the official home of unicorns.

Typically, the unicorn companies fall into four major business models: consumer e-commerce, consumer audience, software-as-a-service, and enterprise software.

As for June 2015, 98 companies in the world are worth over $1 billion. You can see the big data here.

Now, you get the picture.

Unicorn companies are rare, hard to spot and you need to have a special sense to determine one on early stages or the network, the reputation and the expertise in order to be chosen by the founder when it’s already obvious the company is bound to succeed.

Alternatively, you can invest in enough companies and one of them is bound to be a unicorn. As Jerry Neumann laid it out: “One company in 1,538 venture-funded companies becomes a unicorn. If you invest in 1,538 companies you have a 60% chance that at least one of them is a unicorn. Since the minimum-check-size is at least $35k that means to just get 100 companies in the portfolio you need to lay out some $3.5 million. And with only 100 companies, your chances of getting a unicorn are between 6% and 7%. If you up that to 500 companies, your odds are 27%-28%. That would cost $17.5 million”.

Is it worth chasing unicorns?

Yes and no.

It all depends on the amount of disposable funds you have, time and a bit of luck in tow.

So, what are my options?

Set a ranch of ponies.

Quoting Jerry Neumann again: “Built many companies and many products based around a fundamental secular technological shift”.

Once in a while our world is shaken with a new technological movement like wearables, 3d printing, big data to name a few. These movements are big enough to sustain a separate eco-system of companies that can-co exists even with competition.

Extra advantage: if you know the customers of one company within the ecosystem, you know the customers of many. People who run all these companies will know each other, at least by reputation. Business models will tend to depend on similar KPIs, etc.

In other words, if you invest in one company within the sector you will become much more knowledgeable about all the other companies within the same sector.

Here’s a presentation to break it down for you even more:

Learn to identify great founders

At the end of the day it’s all about the people. The founder is the person who will either make use of your money and advice or fail.

What makes a good founder?

Good founders always make this happen the way they need to. They have a healthy respect for reality and don’t back up when things start to go wrong. You should fund people who are relentlessly resourceful and always have a backup plan and a solution at hand.

2. Get ready for going on the grounds

With some general ideas in mind of how many and which company you plan to invest, it’s time to get to action and start with the basis:

Polish your LinkedIn profile

There’s a lot of networking you are going to do with fellow angel investors you’d plan to team up, prospective companies and more. Your LinkedIn should be up-to-date with your accomplishments and clearly experience outlined. Take a look on some top angel investor profiles to get a better idea of what information to highlight.

Register an account with AngelList

AngelList is the most popular platform today where startups and investors can meet halfway. Similar to LinkedIn you’ll have to fill in some information about yourself, your endeavors, locations and markets you are interested in investing into etc.

Join the AngelList syndicate

Syndicates allow investors join on the lead investor's deals. In exchange, you pay “carry or carried interest” – a share of the profit of an investment to the lead investor.

If you are just entering the world of angel investing, joining a syndicate is your safety net for avoiding mistakes and learning at the same time from the more proficient investors.

Yet, you can always go solo or join a local angel investment group in your area. Here’s an up to date US directory listing with contacts.

Determine the best syndicate for you

Depending on the goals you pursue their different criteria to take into account. Interested in investing big, yet taking little responsibility in the negotiation process and post-deal relationships – opt to join an established syndicate. You may need to do some networking in advance to get invited to the club though.

Important points to pay attention to:

• Total carry per deal

• Previous companies and markets invested into

• Expected deals per year

• Minimum investment sum

• Other investors on board as it’s always more productive to work with like-minded professionals.

Here’s the full list of AnglList syndicates.

Create your own syndicate

Setting up a syndicate via AngelList is pretty easy. Go to your profile and open the Syndicate tab. Fill in some basic information for your Backers, which they will use to decide whether they want to team up with you. In the Deal-flow section clearly outline how you get deal-flow and which deals you’re going to choose to syndicate via AngelList. This should be clearly mentioned in case you are planning to do other deals outside the platform. You don’t want your bakers to think you are cherry picking and leaving questionable deals for syndication to split the risks.

Send a round of invitation letters to your personal network announcing your new syndicate. Here’s a sample letter from Venture Beast:

Hey Jill. I’m putting together an AngelList Syndicate to invest, when the opportunity is available. I really enjoyed working with you on [project X] and would love to have your backing if you’re interested in angel investing (even at just 1 or 5k).

I plan to do a very small number of syndicate deals (just one-two per year), so you will only see the best deals I have carefully considered. I also intend to syndicate most of the deals privately (to my backers only). In case you are interested in seeing my first deal, I encourage you to become a baker today.

You can find the details, and also make a commitment if you want to, here: https://angel.co/l/APs8g

Let me know if you have any questions!

Jess

PS: I don’t expect your backing to be a binding commitment. You can evaluate and choose only deals you are interested in without any commitment.

If you don’t have an investment reputation speaking for yourself yet, consider syndicating with your friends, colleagues, mentor etc.

Craft your investment thesis

Your investment thesis is the primary way of how you are going to communicate with your bakers and persuade them to entrust their funds to you.

Here’s a quick checklist to help you craft a winning investment thesis by Venture Beat:

• Novel idea (an underserved market or a new idea)

• Opportunity for large investment returns

• Early examples of success that your thesis would have seen

• Why you’re uniquely positioned to execute against this thesis

• How you will source potential deals

• How you will evaluate deals, and

• (Preferably,) evidence that this is a thesis you can execute against for several years

Create a marketing plan

Some people might take it as an offence, but you need to market your investment deal, unless you have previously acquired Twitter or Pinterest of course.

As an investor, your potential would be identified based on 3 key points:

• Your investment thesis

• Prior success and reputation

• Perceived quality of the recent deals you’re investing in.

The best marketing plan is to show any potential baker you are doing great on one of the following things.

For instance, do a series of interviews explaining your investment thesis at industry events; or if you have a fantastic syndicate deal and the entrepreneur is ok with spilling out the details to accredited investors on AngelList, you promote it within the community and stress why you were so excited by the company.

Received massive exits from the previous company you’ve invested into? Has it been just acquired by Google? Make sure your network knows about it!

Considering you are now fully armed and ready to face the enemy, let talk of how you can identify good deals and where to look for promising companies.

3. Start the search

AnglelList indeed has a huge pool of new companies seeking investment, however if you are interested in going beyond the playground, here are effective statratgies to discover raw gems.

Hunt for talents

The best strategy when you have no reputation, connections or core idea of which companies you want to invest to is to go anywhere you can to find great people.

Come with no specific target in mind, you’re simply looking for unique, brilliant founders (and you already know how to spot one!).

Best advice for a newbie angel investor: research the industry you know best and identify what’s missing from it – do the customers have a problem nobody solves?

If you noticed opportunities, start researching online to hunt down equally smart entrepreneurs that are attacking it. Attend niche events and conferences; get yourself invited to parties hosted by other startups and investors. Be everywhere where you have a chance to run into a unique, brilliant founder.

“Bait” the founders

Once you have made some buzz for yourself and gradually become recognizable, trap the founders into coming directly to you with their ideas.

Trade ideas

Approach other angels – share your deals, exchange your ideas and thoughts. Most of the times, the investors will share their deals back with you. It’s not “give me X and I’ll give you Y” type of trade; just the relationship where you share deals with folks you respect and value.

Host a niche event

Know your investment niche? Host a cool event all “early stage mobile founders” would love to attend. Or trap folks working in edtech.

Sponsor a Hackathon

Host, sponsor and judge at hackathons targeted at specific verticals within your niche.

Speak through social media channels and your blog

You have a following; you have a network – spread your ideas through it. You never know who and when will pick them up and come to you with a ready-to-invest proposition.

4. Found the ideal deal?

Congrats! There's just a few more crucial steps left before sealing it:

Examine company’s monetization strategy

What would be their revenue model? Is it realistic enough? When do they plan to start generating income?

Analyze other investors involved

If you are syndicating the deal with your fellows, you can skip this step. Otherwise, make sure you are on the same page with other investors and won’t have troubles during the next stages of collaboration.

Analyze Return Expectations

Here’s a handy chart to help you out:

Investment Type Internal Rate of Return 5-Year Cash-on-Cash Return

Seed 60% + every year 10X +

Startup 50% 8X

Early Stage 40% 5X

Second Stage 30% 4X

Near Exit 25% every year 3X

Decide whether you need pro-data rights

Pro-rata right are not typically offered in a note with cap structure in seed deals. You should negotiate on them with the entrepreneur in case:

- you plan to stay close to the company and add value

- you are interested in considering reinvestment and be aware of the fundraising process and its timing.

Start the due diligence process

Which can be boiled down to validating the final plan, uncovering the missing pieces and defining the unknown factors that define the risk of an investment.

The process for due diligence is generally as follows:

• Business plan review

• Management presentation

• Onsite visit

• Competitive analysis

• Financial analysis

• The Deal

Conduct company valuation

Typically, valuation of a startup is completely based on the anticipation of growth. Here are core issues to factor in valuing these type of companies according to Tech Cocktail:

• Typical investments

• What investments to avoid

• Ranges of fair valuations

• Factors impacting the valuation

• No specific formulas, as this is more of a black art and a conscientious process

• Estimating valuation using your best judgment

In general, a fair startup valuation will be in the range of $1 million to $3 million.

5. Signing the deal

All point crystal clear, all rights negotiated and papers double-checked by the attorneys. You are ready to put your signature and acquire.

Congrats with your first successful deal!

6. Post investment relationships

On average angel investors spend around 100 hours on signing the deal and around 7 years engaged on a monthly/weekly basis with the company. Surely, you can reduce the amount of your involvement unless you were not the lead investor.

Here’s an excellent piece of what it needs to be a power angle investor after the deal is closed.

Identify the roles

Who will represent the angels on the board – directors or observer status? When the angels exit the board and will there be a rotating angel member assigned? How many boards should angels serve on?

Set up a communication schedule

Do you plan to hold meetings on a weekly/monthly/quarterly basis? How often should the company send you reports? When and on what occasions should you be immediately updated?

Follow-on funding terms

When institutional investors like VCs join the board, the roles of angels have to be balanced with those of the VCs. Angels should help entrepreneurs pick the right angel investors for the next seeding round and leverage their relationships with VCs for a larger institutional round.

Exits

You should clearly agree upon the exit options to make sure you are on the same page with the entrepreneur as far as the long-term strategy of the company is concerned.

7. Run the company and help it develop!

As you have settled on your role and schedule, keep bring value to the company and identifying the founders the right direction to move too. Who knows, maybe you are brining up yet another unicorn?

Here are a few more essential posts you might love to check out:

• Why Angel Investors Don’t Make Money … And Advice For People Who Are Going To Become Angels Anyway

• Tax Tips Every Angel Investor Should Know

• The 4 Most Preventable Mistakes First-time Angel Investors Make

• Lessons for Budding Angel Investors from Y Combinator’s AngelConf: Part 1

• Lessons for Budding Angel Investors from Y Combinator’s AngelConf: Part 2

• Five successful angel investors spill their secrets

• What Angel Investors Care About Most When They Make Investment Decisions