Angel Investors - Are You Fishing in the Right Pond?

Angel investing best practices for diversification
Image by Frits Ahlefeldt -Laurvig

Note: This article is the seventh in an ongoing series for angels new to investing. To learn more about building an angel portfolio, download this free eBook today Angel 101: A Primer for Angel Investors or purchase our books at Amazon.com.

Warren Buffett is known for turning a great phrase. Besides being the second richest person in the world, he is a creative writer with an ability to explain complex topics in a simple and effective way. One of my favorite Buffett concepts relates to his explanation on luck in life. In his biography, The Snowball, he posits:

Imagine there are two identical twins in the womb, both equally bright and energetic. And the genie says to them, “One of you is going to be born in the United States, and one of you is going to be born in Bangladesh. And if you wind up in Bangladesh, you will pay no taxes. What percentage of your income would you bid to be the one that is born in the United States?” It says something about the fact that society has something to do with your fate and not just your innate qualities. The people who say, “I did it all myself,” and think of themselves as Horatio Alger – believe me, they’d bid more to be in the United States than in Bangladesh. That’s the Ovarian Lottery.

Buffett’s concept of winning the Ovarian Lottery is an excellent starting point for the second article in our series on building a diverse portfolio. Why?  Because while there are many components that make up a successful angel investor, the most fundamental truth is that without access to great deals, your odds of making money will approach zero. So in the end, it’s all about getting yourself to the “Right Place” at the “Right Time”.  

Imagine waking up one day and finding yourself living in a small, Southeast Asian fishing village. How many opportunities to invest in local startup companies with high growth potential would you have? Not so many…  Now, imagine you are living in Boston, or San Francisco, or Austin. The number of potential investment opportunities is almost overwhelming. But there are plenty of places in between. Entrepreneurship, innovation and interesting new startups are popping up all over the place in virtually every community. Some great ideas, great teams and great resources are almost certainly  located within a few miles of where you live.

The question is how to find them, and for advice on that, let’s get Christopher’s perspective.

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Q: Christopher, if someone is looking to get into angel investing, how do they find a great fishing guide?

In our first article on diversification, we discussed the importance of building an angel investing portfolio with diversity based on Industry, Type of Entrepreneur and Stage of Company. We also discussed the Capital Requirements and the Time Horizon for angel investing. This question about finding a guide or other access to good deals, is the final, and perhaps most important consideration in building a diverse angel portfolio. Unfortunately, great deals don’t magically appear at your doorstep all wrapped up with a pretty bow. It takes time and energy on your part to find these deals.

For first time angel investors, understanding where to find deals, how to perform due diligence, how to negotiate an investment and how to support the company can be a bit overwhelming. So working initially with experienced angels on your early investments is critical to your success. Just as a fishing guide will take you to where the fish are biting, experienced angels will help you navigate the startup world.

In terms of finding a starting point, regardless of where you live, there should be a nucleus of an entrepreneurial community somewhere in your area or region. Experienced angels can help you meet people and get involved, so networking to find people who are active in the angel space is a great place to start. If you are in a place like Silicon Valley or Boston, the entrepreneurship nucleus dominates your region. Regions such as this with strong entrepreneurial communities have tons of resources to educate and support angel investors.

Other regions, less so, but one particularly powerful shortcut is to join an existing group or network of angels already active in your community. Do some diligence and ask around about reputations to find a group held in high regard by entrepreneurs. Don’t take the group’s word for it, get some independent verification. Organizations such as the Angel Capital Association are great resources to connect with, and they maintain a directory of member groups organized by region.

Q: Where are the best fishing holes? What kinds of organizations and events should a new angel be looking for?

It’s no surprise that many of the best fishing holes commonly pop up in areas with strong entrepreneurial communities. Communities with critical mass of entrepreneurs tend to foster continued entrepreneurial success by having more support systems, potential founders and employees, experienced investors and advisors.  Yet, over the past decade or two, numerous universities and cities not as well known for entrepreneurship have started to develop strong local entrepreneurial centers. Investors such as Brad Feld have been beating the startup drum and creating playbooks like Startup Communities, to help other regions around the world build their own entrepreneurial centers.

In larger cities you will find excellent fishing in a variety of places including:

  1. Universities with business schools or robust entrepreneurship or science programs

  2. Incubators & Accelerators  (both national networks such as TechStars as well as local efforts, vertically specialized programs and corporate incubation programs)

  3. Regional Meetups focused on startup community as well as things like business plan competitions

  4. Co-Working Spaces (from big international chains like WeWork and ImpactHub, to more local city wide systems such as the Cambridge Innovation Center or WorkBar, etc.)

If you can’t find any organizations or events in your region that are similar to the above list, you are probably fishing in a dry hole. It’s time to pack up your kit and head to another nearby location (at least for your angel investing). Depending on where you live, you shouldn’t have to go far to find some interesting activity. I am personally aware of organized angel activity in all 50 US states, including remote places like Idaho and Montana as well as Maine in the other direction. Many successful investors travel a couple times a month to participate in an angel network or other start-up activities in a nearby hotspot. If traveling (or moving) from your current location is not on your list of to-dos, then you may want to participate in a well-regarded angel fund in a city with great deal flow.  

For investors who really cannot find an entrepreneurial center they can feasibly participate in and don’t want to be part of a fund, there is one other type of fishing hole experienced angels can consider. Crowdfunding sites like AngelList and PropelX (and all manner of other similar sites) can give you access to deals from around the world. But if you are a beginner, this is an area where you are going to want to exercise some caution and seek the advice of experienced angels. As I noted in Angel Investing: What’s the Magic Number? this can be risky because there is no guide, there may be little to no diligence and you generally are not going to meet the team. There may be no deal lead or direct investor oversight on the board but some plugged in and experienced angels can supplement their portfolio using these platforms.

Q: How do you evaluate what you catch?

You’ve found an experienced guide and she brought you to a pond with plenty of fish. Even the most inexperienced angler will catch something the first time out given these circumstances. But will you like what you catch? Or perhaps more fundamentally, how do you figure that out?

Recognizing that some failures and mistakes are absolutely unavoidable, and having a sense for what a diverse portfolio should look like before you start investing, are key first steps in the process. Angels have to be mindful that it’s important to spread your risks in multiple dimensions, to have enough cash reserved for subsequent follow-on investments, and to have a long enough time horizon for this very illiquid asset class.

In terms of detailed company analysis, we’ve written at great length about evaluating teams, key risks in angel investing, the importance of diligence, and an entire series on how to conduct diligence. Those basics are important for you to master and I will let those pieces speak to the topics. Here I want to make a slightly higher-level point which is to address more generally the importance of knowing what you are looking for, having filters, and being decisive.  

As you get up the learning curve it is very important to develop a sense of what kinds of deals you will and won’t do and to be decisive about it. There is nothing entrepreneurs despise more than a tire-kicking angel who takes up a ton of their time but never invests.  Developing a reputation like that as you make your way into your entrepreneurial community is a death knell. You do not need to be the smartest angel in the room or the angel with the biggest checkbook or the most marquee name, but you MUST be the angel who respects the time of the busy entrepreneur and either fishes or cuts bait decisively.  

As you learn what you are doing, you should develop two key checklists and keep them in your mind. One checklist should be things you insist on in a deal, and the other should be a list of “showstoppers” which will always keep you from investing in a company.

Each angel’s pair of lists might be different depending on their experience, their risk tolerance and their interests. An angel might have industries they will invest in such as software or medical devices and industries they won’t, such as gambling, or consumer packaged goods.  And she might have certain deal terms she will and won’t do, certain risks she is or isn’t unwilling to undertake. However you synthesize your experience and professional angel learning, you need to have your “must have” and “cannot have” lists and you need to stick with them and respect entrepreneurs’ time by being decisive. I cannot put it better than my friend and mentor John Huston who has observed that “one way to spend less time on more deals, and more time on fewer deals is to have a showstopper screen facilitating swift and consistent rejections - I’ve never lost money on a deal I ducked because it was outside my envelope.”

Happy Fishing!

Want to learn more about building an angel portfolio and developing the key skills needed to make great investments? Download these free eBooks Angel 101: A Primer for Angel Investors and Angel 201: The 4 Critical Skills Every Angel Should Master, or purchase our books at Amazon.com.