Will The Real Angel Investor Please Stand Up?

May I have your attention, please?

May I have your attention, please?

Will the real Slim Shady please stand up?

I repeat, will the real Slim Shady please stand up?

We're gonna have a problem here?

Eminem was asking will the real Slim Shady please stand up in his iconic song in response to many people who wanted to be rappers because it was cool to be a rapper. Now that the funding bubble has clearly burst, the question founders are asking is will the real Angel Investor please stand up?

Angel investing has a pretty interesting history. It started in Silicon Valley many decades ago primarily with retired technology executives and successful founders backing first time founders with risk capital at a stage where no-one would support them. They would typically write small cheques ($25K-$100K) and as the saying goes - fill it, shut it and forget it. One has heard anecdotes of these angels getting a call from the founder years later that the company had a great outcome and they need the updated bank details to remit the (sometimes sizeable) money to the investor. The facts and myths of angel investing in the Valley have created a ground swell across every startup ecosystem in the world. And with the higher liquidity that the world has seen over the last decade and the productisation of angel investing that the likes of Angellist and Letsventure have brought in, has led to a complete explosion in the number of investors and quantum of investments being made.?

Angel investing has gone far and beyond the successful senior technology executives and founders. The Millennials and GenZ are doing it from their salaries. The younger generation of traditional business families are doing it. Even those employed in Government jobs are doing it. Angel investing means so many different things to different investors - from genuinely wanting to support young founders, to seeing it as a get-rich-quick lottery ticket to achieve financial freedom, to it being the flaunty “Mercedes of the 2020s” and of course, as portfolio diversification. Investments were being made over drinks at parties and Whatsapp messages without even meeting founders. As the tide recedes, one does hope that none of these folks financially leveraged themselves or brought financial stress upon themselves/their families to invest in these startups. Because we are going to see a period of pain which will lead to lack of liquidity from secondaries and M&A.

All the doom and gloom aside, it is also time for those who want to do angel investing as an enduring endeavour to also step up. I have been investing in startups for 11 years and having invested in 300+ startups across sectors and market cycles, and seeing many trials and triumphs along the way, I thought it would be good to share what I have learnt that may enable folks to figure out whether angel investing is for them or not, and more importantly, how to be a good angel investor to the founders you support.?

• Be ready to work hard

Angel investing developed a reputation for being “easy money” over the last few years given everyone heard about someone getting a handsome return on a small investment in a short period of time. But consistently doing well through angel investing is hard work. One needs to read a lot to stay updated about the various trends across sectors. An acute level of curiosity has to be married with the physical effort of spending time with founders and voraciously consuming information from multiple sources. Staying intellectually relevant is part of the job of being a good angel investor.

Also going through the investor updates that founders send and keeping them in one’s mind so that when you come across an interesting piece of information or a relevant person, there is an instant connection that can be made to help the founder. Doing this across dozens of investments doesn’t happen on its own. An ongoing investment of time is required to have a current understanding of the companies one has invested in.

• Be available and prompt

Founders expect you to be available when they need you - to run some ideas by you, to ask for introductions, to get your counsel on dealing with a crisis. Founders have a pretty good radar about which angel investor is just in for the ride vs who is actually going to be helpful. Good karma is a critical part of being a good angel investor. Word about your absence and your helpfulness spreads faster and wider than you can imagine, and will impact your success in the medium/long run.

• Have an investment philosophy

Don’t be a hammer looking for a nail. Have a point of view on what spaces you like and have some context on vs spaces that you don’t have a clue about but just think it will make you money because it is hot. The latter approach rarely ends well.

Investment philosophies come in various shapes and sizes. They could range from focusing only on 1-2 sectors (fintech, marketplaces or SaaS for instance) or a particular stage (going in only when an institutional VC is leading) or a particular founder profile (experienced professionals from tech companies). Most angel investors work solo and should appreciate the constraints of being able to completely understand each sector and the competitive dynamics of each opportunity within each sector. You may be thinking you are throwing the dart at the bulls-eye but very easily miss the entire board at the same time.

• Know how to connect the dots in the network

One of the primary reasons founders bring on angel investors is to access their network. Most first time founders have not spent many years in a job and hence their network is limited to the 1-2 companies they have worked at in addition to their college friends. That’s usually not a sufficient network as one builds a company, especially a B2B company where warm introductions are critical. Similarly they don't have a strong network within the investor community. Hence, it is an angel investor’s responsibility to build and unlock their network for their founders. And do it in a timely, relevant manner. Making an introduction literally takes 1 minute, but I have seen some investors take a week or two to send a simple introduction email. That’s totally unacceptable as it is slowing down the founder and that’s not cool. All founders I know are prompt and they expect and appreciate investors who reciprocate the promptness. My belief always is that when you use your network, you strengthen it. So it’s important for angel investors to not feel shy about using their network. This is one of the critical value additions you bring to the table.

• Be consistent

Frequently I receive messages and calls from people I know (and sometimes even those I don’t) who want to get into angel investing. The first question they always ask is how can they get the opportunity to invest alongside Titan Capital. It's not the first question one should ask. The more important thing to figure out in angel investing is your pace and quantum of investing. It is nearly impossible to invest in 2 companies in a year and then not invest in any company for the next 18 months and expect one of the 2 companies to become a unicorn. Consistency is key. Decide the budget you can set aside to make angel investments annually and aim to make 4-5 investments per year. One can’t emphasise the importance of investing across cycles. Like cohorts of graduates (ref: Malcolm Gladwell) have their success determined not just by their own calibre but by the externalities they are subject to, similarly for startups. Why a startup succeeds is not only because of what it does and the team. It’s a big part of it. However, the market circumstances in which the company grows up are pretty important as well. And that is just impossible to time. Hence, the criticality of investing consistently across cycles. In summary, fix a budget, fix the number of companies you will invest in every year, and then judiciously rinse-repeat every year.

• Principal = Sunk cost = Happiness

For every anecdote one would hear about someone getting a big outcome from an angel investment, there are thousands (yes, thousands!) of instances where angel investors have lost their principal. Just to be clear, this is not them making less money or no money. This is them losing the entire amount they put in. And at the angel investing stage this happens probably 7 times out of 10, if not more. Hence, the best philosophy is to treat the principal as a sunk cost. You will be a lot more at ease and ensure that your relationship with the founder is a positive one, where you don’t get the jitters every time the company goes through a rough patch or an unsavoury media story comes out about the company. If you are not stressed about principal preservation, and have treated the invested amount as a sunk cost, you will be happier and always have the mindset that things can only go up from here :)

• This is a marathon not a sprint. Companies take time to build.

Given the fundings were happening big and fast at progressively higher valuations until recently, a belief started setting in that angel investors can do an in-and-out within 2 years. While some people may have lucked out in the peak of the euphoria, one should remember that good companies take many years to build (and sometimes re-build). While everyone likes a 10x return in 2 years, it shouldn’t be considered a given or a norm. One should make investments keeping a 5-10 year horizon in mind. Bear in mind VCs may invest 1-2 years after you invest. And they have a 5-7 year horizon post their own entry. So till the time the company gets to a sizeable scale may take many years, and the 80-20 of value creation is very clearly back-loaded from a time standpoint. Once companies achieve scale they become progressively much more valuable given stronger moats in the business. Hence, stay in the game for long to reap the rewards of the immense risk you took when there were no proof points in the company.

• Have a discipline around exits, especially in your winners

While staying in the game for long is important, it is also important to not get greedy. Nobody can consistently sell their shares in a company at the peak and if a superhuman like that existed, nobody would want to buy anything from them (only to see a fall after they bought it!). Hence, it is crucial to have a threshold in one’s mind around the risk-reward equation that is comfortable. Whenever there is an opportunity to sell your shares where a company has done well, make an assessment of whether you would be buyer or seller in that round. If you are a buyer, then sell 0% and stay invested. If you are a seller, sell 50-100%. If you can’t decide, sell 25-50%. Assuming the company continues to do well, you may experience some seller’s remorse, but over a period of time, if this strategy is consistently followed, you will find that you have sold some a bit earlier than you should have, but also that you sold some at the right time. At a portfolio level, you will likely do just fine.

• Be ready for liquidity issues. You only make a liquid return when a company does really really well.

It is an outlier outcome when a company that an angel investor backs does well. What is even rarer is for the angel investor to actually get liquidity for their shares in a company that does well. Many stars need to line up for a positive liquidity event to occur for an angel investor. The company has to do so well that the demand for its shares far outpaces the supply. Else, angel investors, whose shares typically have constraints (ROFR, limited liquidation preference, no governance rights, etc) tend to get offered a (sometimes materially) discounted price to the valuation at which the company is raising its primary capital. And this is where there is demand for secondary shares. Hence, one must assume nothing as an angel investor when it comes to liquidity. There are no guarantees of a return or of liquidity or of getting the same price for your shares as the primary round of the company. This brings us back to the earlier point of being consistent with an investment strategy and having a long term view.

Being an angel investor is a responsibility, not a lottery ticket. There is a deep sense of responsibility one should feel when you hold any number of shares of a founder's startup. Think of yourself as a custodian of their equity, and not its owner.

So, now with all this effort, thinking and discipline that doing angel investing well involves, will the real angel investor please stand up?Eminem was asking will the real Slim Shady please stand up in his iconic song in response to many people who wanted to be rappers because it was cool to be a rapper. Now that the funding bubble has burst, the question founders are asking is will the real Angel Investor please stand up?

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This post was published in The Economic Times on 27th June, 2022.