When’s the last time you made 100X on an investment?
Not 100% on your initial investment, 100 times your initial investment.
That means you sink $10,000 into an investment and pull out a cool $1,000,000…for many investors this could be a life-changing outcome.
That’s a 100X return, and in the investment community, we refer to this rare event as a 100-bagger. Viewed in the context of average investment returns, it’s nothing but fantasy or wishful daydreaming.
When I polled my Twitter followers, 94% said they’d never had a 100-bagger, and in fact, most said they’d never even had a 10-bagger!
However, while rare, these massive winners are within the realm of possibility for angel startup investors.
For example, when Snap Inc. went public back in 2017, Lightspeed Venture partners saw their $8M early investment grow to about $2B. That’s a 24,900% return, or nearly a 250-bagger.
Or imagine investing in Google’s angel round in 1998. A little-known investor plunked $250k into that round, and with the stock now at a >$1T valuation, that returned….I don’t even want to do the math. (PS: That little known investor was none other than Jeff Bezos, thank goodness he got this win, he needed to catch a break!)
Finally, we could look at another early Uber investor, Jason Calacanis. We chatted with Jason on the podcast back in 2017 about his angel investing journey. Jason boldly lays it out in the title of his book, Angel: How to Invest in Technology Startups–Timeless Advice from an Angel Investor Who Turned $100,000 into $100,000,000.
In Jason’s case, that’s not 100, but 1,000 times the investment!
By the way, Jason was also an early investor in Thumbtack, Calm, Desktop Metal, and Trello. Talk about hitting some winners (that he is certain to remind you about!)
Before we move on, a quick nitpick sidenote: Many commentators assume that if a company goes from a $10M valuation to a $1B valuation then the investor automatically returned 100X. Rarely is this true, as most companies raise money along the way, which results in dilution to investors.
So, the investor may have received a 50X, or 20X, or only a 2X (or less) depending on the funding raised. Think of it like your pizza slice getting smaller and smaller every time the company announces their Series A, B, C, D, E….different share classes can have different returns too.
Most startups and VCs brag about how much money they’ve raised in follow-on rounds, but the most ideal investment is the one in which you invest, the company takes off like a rocket ship, and they never need to raise money again!
With my nitpick sidenote over, the bottom-line is startups offer the potential for vastly greater investment returns than just about anything you’ll find elsewhere.
There’s no mystery behind this. It’s just basic math…
Is it more feasible for a startup to grow from a $10M valuation to “unicorn” status of $1B, or an established giant to grow on the same scale?
Apple could potentially have great returns in the future as they invent teleports, flying cars, and maybe holograms for future Zoom meetings, but how likely is it they will go from a $2 trillion market cap to $200 trillion?
Maybe the aliens will be big fans of Apple products, but mega-size is usually a hindrance to scaling.
But what if Apple decides to give a key supplier contract to a small company valued at just $20 million? Think you’ll see some growth there?
When you catch a small company in its infancy, you’re at least giving yourself a chance at this type of monster return. Mathematically, it’s vastly more challenging for a company to amass this type of return after it gets bigger and goes public…and even if it happens, it’s likely to take a decade or more.
Let’s back up – why am I even writing about this?
I’ve tried to be transparent about my own investing experiences over the years through various blog posts and podcast episodes.
(On that note, here is my last update on “How I Invest My Money”. You’ll see the full picture with farmland, angel investments, coins, collectibles, crypto, and of course, a global allocation with value and trend following ETFs. And don’t miss the other three parts in the series, “The Get Rich Portfolio”, “The Stay Rich Portfolio”, and “Investing in a Time of Corona”.)
Despite the airtime that I’ve given to my angel investments, it seems new questions and curiosities trickle in from readers and podcast listeners.
I can understand the interest. Historically, the world of startup investing has been opaque and limited to accredited investors and venture capitalists. Fortunately, this is changing thanks to relatively recent regulatory changes. It’s no longer a closed-door, old boys’ club.
But in response to the interest, I decided I’d write one, fun, catch-all piece that walks readers through my experiences – the good, bad, and the ugly.
I’m now about seven years into my angel investing experience, with more than 250 investments under my belt. So, while there’s much I still need to learn, I’m no longer a complete newbie. I’ve experienced some 🚀, some 🦄, some 🪦, and lots of \_(ツ)_/¯ (that’s rocket ships, unicorns, gravestones, and “too early to tell” for the uninitiated) …
What I feel confident in saying from these experiences is that – in my opinion – the world of angel investing deserves your genuine consideration as a potential asset class for your own portfolio. From the outsized return potential, to tax benefits, to portfolio diversification, to the built-in guardrails of illiquidity, to plain ‘ole fun, it’s worth it.
So, in this post, let’s get into more details about why I believe all investors should give this asset class a hard look.
A Quick Walk Through the Stats
If you’re more of a recent reader, or you need a refresh on what I’ve written before about my angel investing experiences, here’s the latest overview…
I began putting money into private companies back in 2014. AngelList was, and remains, my primary platform, though I’ve done deals through a handful of other platforms including WeFunder, EquityZen, Republic, BioVerge, and Jason Calacanis’s syndicate. I’ve also co-invested with friends like Howard Lindzon, and made various direct investments with founders I know.
I’ve now invested in over 250 companies that have run the gamut of industries and geographies all around the world – aerospace, robotics, logistics, finance, healthcare, food/beverage, blockchain, biotech, SaaS, education, media/entertainment, payments, real estate, and transportation to name a handful (I’ll get into my preferred deal specs later). There’s been a similar diversity of geography, from California to Miami, to Pakistan, Africa, Mexico, and other far-flung locales.
In making these 250 investments, I’ve reviewed over 3,000 companies. So, by the numbers, I’m only investing in a small fraction of the deals that cross my desk. And since these deals are usually led by VC firms and syndicates that also filter through and invest in only about 5% of companies they see, one could argue these finalists came from a potential pool of tens of thousands of candidates.
As to performance returns, it’s way too early to draw strong conclusions, but for simplicity, let’s keep it only to my exits, since calculating pre-liquidity-event deals is premature and subject to change. You can’t count on a markup or valuation until you realize a liquidity event or that public stock hits your brokerage account.
I’ve had about 20 exits so far, with the highest cash-on-cash return clocking in at a little under 20X. Cool!
There have been three total wipeouts, so a loss of 100%. There were also a couple of near-complete wipeouts. After that, the returns have bounced around from near-flat, to some doubles, a quadruple, a roughly 12-bagger, and then the 20-bagger.
The cumulative cash-on-cash return of these exited companies, including the money-losers, is a shade over 100%. And the average hold period from money-in to money-out was a little under three years.
So, if you look at that holistic return and hold-period, that’s probably interesting enough for most readers to perk up.
But just to try to hook you even more, I’ll tease you with a few examples of companies that haven’t had liquidity events yet, but they’re enjoying massive growth.
First, there’s FabFitFun. I invested in a seed round in 2015 with Draft Ventures when the company was just getting some early traction.
Fast forward to today, where they reported over two million customers and $600M in revenue in 2020…and they’re still growing. (You can listen to an upcoming podcast with one of the founders, Katie, who is an incredible force of nature….)
Then, there’s PlushCare. That was another 2015 seed round investment with Moso Capital. They were recently acquired by Accolade for $450M in cash and stock. I didn’t include them in the exits list yet as it has not closed, but it has potential to surpass the biggest winner status… (Podcast with the founder Ryan here.) Two more companies going public soon include Momentus and ATAI…
We had the founder of Grove Collective on the podcast recently. Grove was a 2016 investment via Phil Nadel (another podcast alum – he mentions Grove in the episode in 2018). They focus on eco-friendly home essentials and have executed with laser focus, blowing by unicorn status well on their way to greater heights. I think there is real decacorn potential for Grove (that’s a $10B valuation).
There’s also ShipBob, a global logistics platform that fulfills ecommerce orders for direct-to-consumer brands, which was a 2016 seed investment. They’ve raised over $100M in follow-on financing hundreds of millions in funding with a unicorn valuation, and are continuing to grow like a weed. (Had to update this today due to new funding announcement.)
You will notice many of these are from early vintages, so perhaps I was simply lucky during the early days. I’ll take it! But there have been some recent rocket ships too.
Chipper Cash is a fun one. I invested alongside Joe Montana and others in both the seed and Series A in 2019 and 2020. Chipper has kept growing, recently raising $100M in their Series C round. They were recently described as one of “Africa’s most valuable startups”. (We had the founder, Ham, on the podcast to tell his story too.)
Given how many times I’ve tweeted about finding lost assets on Unclaimed.org (go search if you haven’t and let me know what you find, we’ve found millions for followers), I’d be remiss not to mention MainStreet. I invested in their seed round just last year in 2020, and my goodness…They have such a cool story (they help companies claim tax credits) and such an obvious product market fit (zero cost if they don’t find any) that I’ve invited the founder on the podcast twice already. The average company saves over $50k, and they’ve collectively saved U.S. companies over $100M.
Now, before you start thinking these types of success stories are all over the place, let’s adjust some expectations.
I am fully aware that I’ve been investing during a romping, stomping, bull market.
At some point, if and when the broad U.S. stock market goes down 40%, 60%, or even 80%, angel returns may not look so rosy. Funding will dry up, exits will become scarcer, VCs will stop being super douches on Twitter, and many companies will go out of business.
But the flip side of this bearish scenario is valuations will go down too – so you’ll get more bang for your buck. And some of the best companies in history were founded during bear markets – Uber famously was founded in March of 2009!
I’ve committed to investing all the way through the full business cycle, which is just another form of diversification. To me, an investor has to: a) diversify across numerous investments, b) diversify across multiple sectors c) diversify across geographies, including international borders, and lastly, and our current point, c) diversify across time.
Right now, I have investments ranging from brand new seed startups raising at $5M, all the way up to mature unicorns doing hundreds of millions in revenue. Some companies in my portfolio benefited from COVID lockdowns while others got crushed. Some of these biotech companies will live or die by results that will not even be presented for half a decade or more. Their success is unlikely to be correlated to a delivery app in Venezuela. (Yep, I said Venezuela!)
So, circling back to the point here…
I’ve included all this detail to emphasize that I’m no longer a newbie. So, let’s now dive into why I’m endorsing angel investing to you today.
The Good and the Bad Details of Angel Investing Returns
While I’m obviously happy with my biggest exit being a near-20X return, in the broader context of what’s possible in the private markets, that was not a massive outcome.
Most of us would be dancing a jig, or perhaps, in the more modern world, bragging on Twitter with a stock doubling or tripling, let alone going up 20 times!
This is perhaps the most exciting, distinguishing feature of startup investing when compared to the later stage markets. And we can thank one thing for it…
When it comes to investing in startup companies, power laws play a huge role in the distribution curve of returns. Now, it’s important to understand that this can be both a blessing and a curse.
In your normal bell curve distribution, it’s impossible for a single data point, or even a handful of data points, so have an outsized effect on the overall distribution.
That’s because the distribution average is heavily centered. With so many data points falling in the fat part of the curve, a single outlier isn’t going to impact the overall average much at all.
Power laws don’t work this way.
They’re far more in keeping with the 80/20 rule, wherein 80% of an outcome is determined by 20% of the input. Or more accurately for angel investing, the 95/5 rule.
With a power law distribution, just one or a few extreme readings, can have a profound impact on the average of the entire data set.
Consider the average net worth of you and your golfing buddies. Maybe it’s a $1M average, nice crew!
Now, let’s say Warren Buffett and his $100 billion fortune joins you for a round, so you recalculate the group’s average.
How is Warren-the-outlier going to skew the number?
Well, you’re now all billionaires (on average).
But is that new average even remotely representative of your personal net worth? (If so, you clearly don’t need to be reading my blog.)
I saw this dynamic myself with my 20X-winner helping pull up the average of my portfolio of exited companies, despite having a handful of investments that lost 100% or near-100%.
But keep in mind what this means…
Given how just a few outsized returns in a power law distribution can radically skew the return of the whole portfolio, it becomes critical that you, as an angel investor, land one or more of these long-tail, massive winners. That’s because they’re not just fun, they’re required in order to bring up the average return of a portfolio that will have a great deal of ho-hum and money-losing returns.
And what that means is you need a lot of data points…in other words, your money spread out over lots of private company investments.
Last summer, AngelList published a study it conducted on this. In short, the platform selected all of its investments prior to Series C that were at least one year old and had a valuation change, or that had already exited. These parameters gave them a universe of 1,808 investments.
AngelList tried a strategy based on VC veteran Peter Thiel and his approach, which is to concentrate on seven or eight promising companies. AngelList upped it to 10.
Here are the distribution of returns for hypothetical investment managers that roughly followed Peter Thiel’s advice and made 10 investments out of the universe of 1,808 that we originally selected:
The black vertical line represents the market return, which is what you would get from writing an equal-sized check into all of the potential AngelList investments.
All of the probability density to the left of that vertical line represent hypothetical portfolios that underperformed the market return.
The most frequently observed outcome from a 10-investment portfolio, the peak of the curve, is slightly positive performance, well under the market return.
This is a consequence of the power-law returns of venture capital: the typical manager fails to pick any outsize winners in their 10 chances, whereas the market portfolio is assured of selecting all of the return-driving winners.
Given this, for the average private investor, you’d be better off reducing your bet size so you can spread your capital over more deals, than you would be concentrating your money in a smaller portfolio.
The study found that the best simulated 10-investment portfolio from 50,000 random draws generally had around a 19x multiplier, miles off the chart above (that’s before fees).
But circling back to the original point here, startup companies offer greater potential for these massive outlier returns that are part of a power law distribution. Hunting for them, and watching one appear to be developing is lots of fun and very exciting.
Some of the top angel investors understand this very simple concept. Jason has invested in over 300 companies and Fabrice Grinda, who has also been on the podcast, has done over 700!
Again, it’s not a unique insight, but it’s a critical insight. Make sure you implement this “more is better” rule when you begin your own angel portfolio.
Before we move on, one final note…
Power laws also work in the public stock market. (This is a common misconception many VCs have that this characteristic is unique to private investments.).
In fact, power laws are one reason why market-cap-weighted indexing works – you are guaranteed to own the winners. And most research shows that about 10% of stocks deliver ALL of the return. Your average stock probably underperforms T-bills!
***Seriously, if you just skipped over all of the above resources, don’t. Print them out, read them, and listen to the podcast.***
The Second Reason Why I’m A Huge Advocate for Angel Investing – Illiquidity
We just said that power laws apply to public markets too.
Case in point, Amazon.
If you had invested in Amazon at its IPO, you’d be up somewhere in the tens-of-thousands of percent at this point – a huge outlier compared to the broad market.
But – and this ties to our next point – even if you had invested in Amazon at its IPO, the odds of you not selling it before it hit that monster return would be next to nil.
The reality is that unless you received your Amazon stock as a physical stock certificate, lost it for a couple decades, then found it again, it’s a near certainty you wouldn’t still own Amazon.
After all, would you have held from Amazon’s 1999 peak of $113 as it crashed all the way down to $5.51? That’s a 95% loss. Remember Amazon.bomb?
Would you have held a few years later in 2008, when it fell from $101.09 to $34.68? That was “only” a 66% loss.
There were two other 50%+ drawdowns in Amazon’s history too. You’re going to sit through all four of those collapses despite your mortgage, or your kids’ braces, or college tuition, or retirement, or you-name-it?
On the flip side, how tempting would it have been to cash out those Amazon shares if they doubled?!
Think of all the things you could buy, the vacations to go on….
A 10X investment would likely have been life changing. Who is going to hold on beyond that?
Investing in private companies provides a wonderful solution to this, which is our second point…
In other words, you CAN’T sell, even if you wanted to. This is a feature, not a bug.
After you invest, that money is gone until the company enjoys a liquidity event of some kind or locks its doors for good. So, you’re in it until the end.
But again, I see this as a good thing. It prevents the self-defeating investment behavior that the academic studies highlight year-in, year-out.
Illiquidity can be a gift that saves us from ourselves.
It’s easy to get rich with even 10% compound returns, as we’ve demonstrated in our “Get Rich Portfolio”. The problem is you need time, and most people want their riches NOW.
“Now” used to mean quarters and years, but in this Robinhood world it means minutes and hours…
Seeing huge, overnight winners from meme stocks can make investors lose focus, and make foolish choices in their public portfolios. You won’t have such an option in your private portfolio.
Instead, those companies will have all the time and breathing room necessary to develop to their full potential (instead of you deciding that selling your shares for a new Tesla and golf clubs is the right move).
Think about it a little bit… angel investing is the ultimate trend following strategy. Your stop-loss is zero, and your upside is uncapped. It reminds me of the old David Ricardo quote from the 1700’s, “Cut short your losses, let your profits run on.“
(It has always been interesting to me there is not more overlap between the macro trend followers and the angel startup crew, as they both essentially have the same philosophy. Is the ultimate portfolio half trend, half angel investing?! The trend side should help hedge the long equity bear markets too…)
The Third Reason Why I’m A Huge Advocate for Angel Investing – No Daily Anxiety
Though we all recognize that investing should be a long-term, multi-year endeavor, too many of us treat it more like a daily casino.
Thanks to our investment apps, we’re able to watch every little market movement. This puts us at risk of our emotions getting hijacked by the volatility, leading to kneejerk, emotion-based decisions. Confetti cannons!
People used to ask me at cocktail parties, “Meb, I bought one of your ETFs, how long should I give it to see if it works out?”
I would respond, “10 years” to which they would awkwardly laugh, assuming I was joking.
After a few moments of silence, they would respond, “Wait, you’re serious…” and then they would go find someone willing to talk about something more interesting or immediate, like Dogecoin.
Now, returning to a stock like Amazon, you think you could be the one to hold through the ups and downs? Let me rephrase that, through the many years of ups and downs?
If so, the stats are against you. I polled Twitter to ask, “What stretch of underperformance by a portfolio manager would you be willing to tolerate before selling the allocation?”
85% of responses said under six years. 53% said under three years.
This is everything wrong with investing wrapped into one poll.
By the way, remember when Amazon took it on the chin back in 2001? It took nearly a decade before it made its way back to a new all-time high in late-2009…only to get chopped in half again.
Every asset class, or strategy, or specific investment, can go years, even decade underperforming. Take the most universal belief in all of investing: “stocks outperform bonds”.
Well, guess what?
In 2020, stocks had experienced similar returns as bonds for not three years, not six years……but for 40 YEARS.
That is four decades of no equity premium.
But you’re telling me you can only wait three? GTFO of here.
Circling back to our main topic, here too, the private markets have a built-in win.
Unless there’s a recent price round or liquidity event, the market value of one of your private investments is vague at best. But this lack of detail encourages a wonderful investment practice called “forgetting about it.”
This concept was best described by Robert Kirby in the 1980s essay “The Coffee Can Portfolio” in the Journal of Portfolio Management.
There’s something nice about not being able to price your portfolio, week-in, week-out (or hour-in, hour-out). It’s in keeping with one of my favorite quotes that you can find here on the blog. From George Mallory:
“And joy is, after all, the end of life. We do not live to eat and make money. We eat and make money to be able to live. That is what life means and what life is for.”
As I see it, private investing is vastly superior to public market investing when it comes to helping you focus on what’s important in life.
The Fourth Reason Why I’m A Huge Advocate for Private Investing – Massive Tax Advantages
These advantages relate to an IRS designation known as QSBS (Qualified Small Business Stock) or Section 1202.
We polled our Twitter audience and over 90% had never heard of QSBS. And yet it may be the most impactful tax move you can make in your entire portfolio.
A QSB is a company whose gross assets—valued at the original cost—don’t exceed $50 million on and immediately after its stock issuance. Plus, to qualify, you will need to hold the investment for five years.
There are some additional restrictions. For example, certain sectors like mining and farming aren’t eligible. But when the company and the investor meet the QSBS requirements, capital gains are exempt from federal taxes.
Wait, say that again?
It’s pretty amazing – investors can exclude 100% of their taxable income up to either $10 million, or 10X their original investment – whichever is greater.
Now, there are other fine print details. So, you should consult your CPA or attorney about how they relate to your specific financial situation. That said, the takeaway remains the same…
The government is incentivizing startup investing in a massive way. Especially when compared to the public markets, wherein the government is looking to double federal capital gains taxes for wealthier Americans.
This alone is a big enough reason to think seriously about angel investing.
For those that want to invest in private companies in their retirement accounts, I use AltoIRA for two of my retirement accounts and am also an investor. Peter Thiel was recently in the news for growing his IRA to a whopping $5 billion. Tax free!
The Fifth Reason Why I’m A Big Advocate Is the Simplest – It’s Fun
I think browsing startup offerings is loads of fun. I find it thrilling to see what products and services are being cultivated.
Many times, you’re at the cutting edge of a technology or product. In other words, you’re one of the first people to see what’s coming. It’s genuinely exciting.
In addition, I’ve incorporated countless company’s services, products, and ideas into my own life and business. Most of my friends and family are sick of hearing me say, “have you heard of this cool new company…?”
Plus, it breeds an optimism that, all too often, isn’t there with public market investing. Turning on your average business network or browsing news sites is a depressing experience filled with shouting, short-term thinking, partisan views, and overall negativity. Plus, it trains you to focus almost exclusively on the short-term market price.
With angel investments, the inability to value a company daily, and your powerlessness to have liquidity even if you could value it, put the focus back where it should be – on the idea and the leadership team… on building something… on the future and what could be.
For example, here are a few companies I invested in that are simply doing ridiculously cool shit:
- Take Axiom Space. They’re building the first commercial space station. And we’re not talking about completing it in, like, 2050. Private flights begin next year with their first module attaching to the ISS in 2024. You think your TAM is big, how about THE ENTIRE UNIVERSE?! (You can listen more in the Lisa Rich podcast as well as an upcoming show with Axiom.)
- Or how about Fellow. Name something grosser, or more awkward, than a dude going to a clinic and having to, umm, produce some sperm. Yuk. This might be the ultimate in “frustration arb”. Fellow is enabling thankful guys everywhere to do the deed from home. Eventually, it will have the world’s largest sperm storage, testing, and bank for pharma research.
- Perhaps you are worried about global warming, and care deeply about the planet and reforestation? Want a quick way to plant a forest the size of a country? Make it happen with drones. I said DRONES! Check out DroneSeed.
- I always though 23andme is a cool idea but there are two big flaws in my opinion. One, it’s basically mostly U.S. and European samples, and less than 3% of genomic data available is African. Two, they also charge you to take your DNA, then sell it to pharma companies, and then they keep all the money. WTF? 54 Gene is focused on collecting samples from Africa, but also returning a portion of the proceeds to local communities and institutions. Win/win.
- Tell me you don’t want to go stay in one of these Bubble Hotels. Do it just for the GRAM.
- Do you support youth sports? Honestly (minus the parents), it’s one of the best ways to teach kids important life lessons. LeagueSide was built as a marketplace to match sponsors and teams. Want to sponsor a local team, or even do a national campaign focused on under-sponsored demographics? LeagueSide can help (Podcast here).
- Speaking of sports, how much would you like to watch your grandchild play high school basketball live? Many can’t travel due to distance, health, or they simply hate their in-laws. BallerTV fixes that.
- Here’s a biotech developing a drug for severe COVID patients. Will it work? It’s never certain with clinical trials but they just dropped some positive Phase II data.
- Loneliness is an epidemic, especially for many grandparents…. Papa tries to solve this with “family on demand”. Papa pairs seniors with “Papa Pals” to help run errands, play chess, or just have someone with whom to talk. Think how beneficial it is for younger generations to learn from all the wisdom of our elders too. I think this company has decacorn ($10B+) potential.
- How about surgeons training via VR?
- Metaverse Horse Racing. Yep, that’s a thing with Zed Run.
- I love tattoos. For many people, tattoos are cool…for about a week, then the regret starts to creep in. Inkbox fixes that with gorgeous two-week tattoos. Also, if you have kids, they go bananas for them.
- Lastly, obviously we’re going to need gas stations in space.
I could go on and on, but I hope you’re getting the point, which is…
It’s just more fun.
So, quick summary on why you should consider angel investing:
- Potential for outsized returns.
- Illiquidity may help you hold on long enough to realize the big winners.
- The long-term perspective can remove the daily anxiety of the stock market.
- Potentially massive tax benefits.
- It’s fun to invest in, and support, kick-ass founders building world-changing companies!
Sounds a lot like the Warren Buffet approach, doesn’t it? (Except at a much smaller scale.) Invest in great businesses, hold onto them forever, and as my friend Wes Gray would say, “compound your face off” …
Practical advice for getting started
When I began seven years ago, I knew there was much I needed to learn. So, my mindset going in was basically “follow the top investors, read about companies and founders, learn, develop some experience, when comfortable begin placing lots of little bets, repeat.”
I’m influenced by Charlie Munger’s quote that graces the back cover of my book (free to download) Invest with the House:
“I believe in the discipline of mastering the best that other people have ever figured out. I don’t believe in just sitting there and trying to dream it all up yourself. Nobody’s that smart.”
So, when I started, my primary goals were to learn and to enjoy myself. I was not trying to hit it out of the park financially.
From this perspective, I viewed my invested capital as a reasonable tuition/entry fee. You can listen to old podcasts in which I say my goal was to break even, and if I made a few bucks, great! If I beat the S&P 500? Even better.
So, I would answer “how to get started” by asking a return question – “what do you want from it, and what are you willing to give to it?”
By “give to it” I’m not only referring to money. I’m talking about time, study, what role/allocation in your overall portfolio, and so on. Some may see all of the below as “work,” but I don’t.
All of this points toward creating a personalized plan.
In creating this plan, you’ll want to answer some questions…
How much will you invest? There are two sub-questions here. The first is how much cash do you have right now that you want to use to seed your portfolio.
A word of advice here – do not feel the need to blow all your investment capital into a batch of companies at the very beginning. Every deal you’re likely to see in the first few months will sound amazing. A better plan is to design a five-to-ten-year roadmap with target dollar amounts and target number of companies per year.
Yes, the power law distribution needs you to have lots of investments, but no, that’s not a license to throw money at any opportunity that fills your browser. People disparagingly like to call this “spray and pray”. If you’re like me, you’re going to pass on roughly 90-95% of the deals you review.
So, your goal should be to get fully invested, but do so deliberately.
The second related question here is how much capital will you commit to adding each year?
Again, this is not a one-and-done process. As just noted, you need lots of investments as you try to find those long-tail power law monster-winners. So, a commitment to that challenge is important. What will that mean for you?
Maybe that means you’re going to invest $100k total per year across 100 startups for the next ten years. Or maybe it’s $20k per year in 20 startups for the next five, and then reevaluate. Some months you may do no deals, and some you may do multiple.
Next, ask yourself how you will judge the process to be a success or failure. By a return percentage? By how much you’re enjoying it? By how much you’ve learned? Relative to a benchmark, such as your public portfolio?
It’s worth jotting down all the various ways you could judge it, after which you can try to ascribe some quantifiable metric to each one. A sort of “line in the sand” for evaluation. Even if you can’t measure it, writing down what you hope to achieve will be helpful.
Beyond that, will you focus on any specific sectors? Or will you go anywhere an attractive deal takes you?
How will this fit into your broader portfolio? What percentage of your investible assets will this take up?
There are plenty of other questions, but they’re all largely focused on one thing…
Setting and managing your expectations.
To that end, prepare to see your money locked up for years… prepare for the unpleasant feeling of watching some of your companies go bust… prepare for some wins, along with plenty of ho-hum returns… prepare for dilution… prepare for three-to-seven years of twiddling your thumbs before any fireworks happen (hopefully sooner) … prepare to be surprised when your favorite deals don’t do much and the boring ones take off… prepare to be humbled and to learn, but have a great time in the process.
I like to make the analogy to farming.
I plant some seeds in different fields every year. Some of the crops produce in year one, like wheat, whereas some take years to mature, like almonds. Others, well, they get hit by drought and disaster and you just have to start over with something else.
Or perhaps a better analogy would be wine-making with various vintages.
Let’s say you start out making wine in 2015, but that vintage doesn’t seem like it is going to reach peak drinkability for 5-10 years. Or what about 2016 vintage, in which there were local fires, and the smoky wine may be a total write-off? Meanwhile, 2017’s vintage was unexpectedly delicious right out of the barrel.
Fast forward to 2021 and you now have seven years of vintages all maturing from different times and of varying quality…
(This is an illustration of an earlier point – diversification across time is very important.)
In terms of some more actionable advice, I recommend joining AngelList and/or whatever other platforms you like. There are even stand-alone syndicates out there like the one I referenced earlier from Jason Calacanis – it’s called “The Syndicate”. You should also consider signing up for Jason’s Angel University Workshop. It’s $300 to attend and all proceeds goto charity.
When you’re on any of the platforms, you can begin browsing the deals from the various syndicate leads. Often the deals are confidential for various reasons (terms are not published, company is in stealth, they don’t want to alert competitors, etc.). At least once, I saw a syndicate lead try to raise money for a company without their knowledge – definitely a no-no.
At first, I’d recommend you follow as many syndicates as possible. After all, your goal should be soaking up information and seeing deal-flow. I follow over 100 on AngelList (and have invested alongside dozens), which results in hundreds of deals crossing my desk each month.
I like the flow but understand for many this would be overwhelming. Because it’s a lot to track, I commit more headspace and attention to my “favorite investors”. So, perhaps get started with a few of the syndicates we’ve interviewed on the podcast, as I’ve invested alongside all of them.
After enough of this, you’ll begin to gravitate toward a specific type of deal that resonates with you.
Here is my playbook.
I like a company between $5M-$20M. That’s my sweet spot, so we’re basically talking a seed round or Series A. You may prefer lower risk, later stage companies, which is fine.
I’ve done a number of deals as low as $2M, and a handful above $20M, but nearly all of the deals are below $50M (again, I want the possibility of the big 100X outcome).
I reserve some later stage market cap deals for companies I love, aka the “Peter Lynch” method. If you listen to the podcast, you’ve probably heard me talk about some of these later stage companies I’ve invested in like Impossible Foods, Omaze, Lyft, and Hotel Tonight (now Airbnb). I try to avoid paying carry on later stage companies, and many secondary markets have liquidity for these companies.
I tend to stay away from pre-launch companies. That’s because I want to see an existing product or service with around $1M revenues as proof of concept. If all you have is an idea and a dream, a lot can go wrong.
So many startups tell you what they’re going to do, but I prefer to see the ones that already have a little of that “product market fit”. I tend to bypass pre-seed companies unless I know the founder or absolutely love the idea.
Other investors are willing to bet on just an idea or founder. And that’s cool too, you just have to find what works for you. This is not a one-size-fits-all operation.
A quick note on deal writeups. You may want to spend the first few months simply reviewing deals. You’ll notice some familiarity with the jargon, notice some pattern recognition, you’ll develop some preferences, and get triggered by some red flags too.
You’ll learn to put little weight on a memo that reads “this is one of the FASTEST growing companies I’ve ever seen. I expect them to reach $100mm ARR by 2023…in fact the deal is 3X oversubscribed so we only have this allocation thanks to my value-add to the CEO, I’ll do my best to ask for a larger allocation. We need to wire money in the next 24 hours so make sure to get your commitment in ASAP” …
Go ahead and laugh, I see these on the DAILY.
You want the possibility that a company can reach $100M in revenue per year, which potentially gets them to a unicorn valuation of $1B. There are lots of great companies that may only get to $10M (a great business!) but you want to avoid them as they will not drive the power law outcome. Strange to say but true…
Target Sectors or Themes
A few of my favorite categories/sectors are aerospace and biotech (no surprise there given my background), mental health and happiness, emerging markets, food 2.0, decreased consumption, and of course fintech!
But you’ll also find yourself gravitating toward investment themes, not just sectors.
For example, I’ve labeled a type of investment theme that I prefer “frustration arb.” Basically, I’m investing in a company that’s making a process smoother or frictionless. Think “something we all need but hate dealing with.” What industries have a low NPS score, or said more technically, “what out there sucks”?
You can see how a frustration arb works across countless sectors, though the specific solution varies. The bigger the frustration that the company is relieving, the bigger the potential payday.
For example, real estate has endless frictions with high fees. It is just littered with spots for disruption. Recall your real estate agent just got paid $120k for doing what exactly?! Think those 6% real estate commission are toast like I do?
Homelister is disrupting that market, and fast. Sorry, broker friend, you’ll have to finance that Aston Martin somewhere else…
Anywhere people still do business in Excel, or even better, pens with yellow notebook paper, is ripe for frustration arb. Lots of emerging markets qualify, but plenty of U.S. industries are overlooked. Think billboard advertising, a notoriously inefficient and fragmented market. Enter AdQuick (listen to podcast episode for fun Serena Williams story).
Here’s an example of how creative these solutions are becoming…
I can’t think about anything more frustrating, or embarrassing, than being a terrible dancer (not speaking from experience…ok, I am). Many people would take dance lessons except for that part, again, it’s too embarrassing.
Steezy has revolutionized dance instruction straight to your living room. Nobody cares if you’re dancing in underwear or looking like Elaine from Seinfeld, so let your freak flag fly.
Now, looking at all this from the opposite side, what doesn’t grab my interest as a potential investment?
A product that helps Google sell more ads. Barf. Boring.
I want to have portfolio companies I actually care about. Listen to this podcast episode with Tom Williams and you can hear in his voice how passionate he is about his portfolio companies.
I want to be excited about the idea and cheering for the founders to succeed at every turn. You’ll develop your own preferences, and these may be guided by your own value-add too.
Target Portfolio Management
My goal is to make about 50 investments per year. I have a default “unit size” for my initial investment. You should decide ahead of time what that number is for you – could be $1k, $5k, $25k, or even $100k. Whatever is appropriate for your situation.
Sometimes, if I really love the company, I’ll go double, or even triple my default, but I have a hard cap that is a max multiple of 4X my standard unit.
On the flip side, sometimes I will invest in a company with an amount lower than my default, just to follow along with its progress. Something like ¼ of a normal unit.
This reminds me of old school stock investors that will buy one share of a company just to get the annual reports, so they remember to follow along. Further investment for me is usually milestone-based, such as, “if they hit these milestones in the next 12 months, I’ll fully invest.”
I will rarely join in a follow-on investment however, and this diverges from many investors’ advice. If I invest, say, $5k into a startup, and they raise their next round at a 10X valuation, I already have a large position relative to my initial unit size, ignoring dilution.
(Another way to think of it is like having no position, and then deciding to invest $30k from the start. Would you do that? Probably not.)
So, it’s rare that I’ll do a follow-on round. I believe I’ve only invested in about a dozen of them out of my 250 investments. The opportunity must be especially compelling.
But for the right opportunity, I believe it’s worth it to throw some more money at a company that’s doing something special. If there is a company that is an absolute rocket ship, or where the opportunity is especially compelling, I’ll invest multiple times.
An example of a follow-on round I participated in was with the company Chipper, a payments app. It’s a bit like PayPal for Africa.
It’s growing so much, and so fast, I felt it warranted another investment.
In addition to Chipper, the other companies I’ve invested in multiple rounds are Albert, TenSpot, Inkbox, Homelister, Grove, Possible Finance, RoboTire, Yummy, Wave, and Yassir.
I’ll note that as I keep seeing valuations going stratospheric in the dozen companies I’ve invested in twice, it’s interesting to remember that almost all of them began with a seed round of less than $10 million. It’s also hard to look back at all the big winners and necessarily correlate my initial excitement (dude, this is going to be the next Uber!) and the actual outcome (wait, the founder decided to pivot to WHAT?!). You can hear Peter Livingston talk about this in our podcast “All My Best Investments Were The Ones I Couldn’t Get Anyone Else To Do”.
And while we’re on the topic of valuations, how does one even value these early-stage companies?!
Certainly not a 100-page DCF and 10,000-row Excel model. Most seed rounds range from $5m to $10m, although this can easily change based on the business cycle (I just saw a pre-revenue seed recently at $50m), as well as intangibles like founders, traction, etc.
Most of the recurring revenue style companies tend to get valued at around 10X sales ballpark, with adjustments made for industries with worse margins.
I keep a running list of most of the investments I’ve done on a public Twitter List. Feel free to follow along. (FYI – A fair amount of the companies referenced are not on Twitter, or they’re based abroad, or still in “stealth”.)
Overall, focus on the process and learning, not necessarily the outcome. In time, you’ll develop a system and deal parameters that align with your goals. You simply have to start and stay committed.
Learning Lessons and Things to Know Up Front
Five final thoughts…
One, sometimes founders like to update their investors on progress and setbacks, sometimes they don’t. It’s odd to me why they wouldn’t utilize an engaged shareholder base as a resource, but many founders go “full turtle” during hard times and retreat into their shell.
On the flip side, I’ve seen many founders fail with grace and courage, and I would 100% invest in those founders again. Think of all the lessons they learned for next go round…
Two, if you invest through a syndicate, realize the syndicate leads may have their own incentives to guide them. So, you might find a lead selling a holding earlier than you’d prefer, because he/she wants to lock in their carry.
Or the lead might sell a company that you love, even though it’s having trouble getting traction, because the lead wants the mediocre performer off their books.
You won’t have much of a say in this. It can be frustrating, but it’s just part of the process.
Three, do not immediately dismiss ideas that “sound stupid” or are “too ambitious”. I passed on the seed round for Boom Aerospace, as in my head I thought “a startup tackling supersonic travel? No chance” … They recently reported that United will buy up to 50 of their planes. D’oh.
There will be lots of missed unicorns on your “failure resume”. That’s fine, as you don’t have to invest in all of the unicorns, just one.
Four, I’m asked occasionally about investing in angel investing funds. By design, I don’t invest in funds as it doesn’t check the box for why I’m investing in the first place (learning, reviewing deals, making picks on my own, etc.). So, I only have one fund investment to my name from the early days. What I will say is that it is a wonderful reminder about the power law dynamic of angel investing.
This particular fund I invested in back in 2015 has 19 holdings. A full seven of them already went belly-up. A complete 100% loss.
Another seven only are surviving or muddling through and likely to return only the initial investment amount. So, no gains, but at least no losses.
So, out of 19 holdings, we now have 14 that have either lost money or made $0 in profit. Sounds terrible, right?
This is where it gets fun.
There are three solid winners, which are still live and growing. Ginkgo Bioworks, coming in with a near-14-bagger. ShipBob, with a 19-bagger (likely more due to new funding round this week), and then Checkr, with a wonderful 76-bagger.
Best part is they’re not done yet! (Worst part, they’re not done yet and could still fail too!)
Overall, those three power law outliers have raised the overall portfolio average to a 5X return at last check…even though 74% of the portfolio-holdings are duds (so far).
Fifth and last point – how do you handle it when a company is a rocketship?
Specifically, we’ve covered position-sizing at initial investment, as well as follow-ons, and what happens when a company goes to zero (well nothing, duh), but what happens when a company works?
Let’s say your plan is to invest in 100 companies over five years with $10,000 each. And let’s say halfway in, you hit the lottery and one of these companies goes full rocket ship and hits unicorn status. It goes public, and suddenly, you have a 100-bagger in your E-Trade account. Woo-hoo!
But, what now?
You must have a plan for the right tail too. What happens when things work?
Your original plan was to invest in 100 companies, but you’re only at 50, and your one holding is worth twice the rest of the portfolio combined….
Do you trim and sell some? Do you take all your chips off the table so you can play with “house money”? Or, if the prospects are positive, do you continue to hold all the shares and let it ride?
What if that 100X is just the first stop on the way to 1,000x? That $1M position could be $10M?!
There’s no “right answer,” there’s only “the right answer for you.” So, think through this stuff ahead of time, so you don’t let emotional decision-making creep in…that’s where the fractures occur. Perhaps you will scale out at every funding round, or maybe sell X amount if it increases past y% of your portfolio. But all in all, a good problem to have!
So, quick summary on how to craft a plan:
- Start following lots of angel and VC leads, listen to our angel/startup shows on the podcast. Read Jason’s book and sign up for the workshop.
- Start reviewing deals, and be in no rush to write the first check. Wait and watch for months and start to understand all the jargon, red flags, pitfalls, etc.
- Decide on your annual dollar commitment. (ex $100k per year).
- Decide on your standard unit position size (ex $2k). Likewise, decide if and when you will deviate from this sizing and by how much. (ex half-size for a pre-seed to track, 2X for head-over-heels ideas, etc).
- Decide on if you will do follow-on investments, and if so, position sizing.
- Decide on the ballpark number of deals you will do per year.
- Decide on full cycle commitment of 5-10 years, and ideally, place though funds in a segregated account.
- Decide on what you will do with big winners, if and when you will scale out or sell.
- Sign up for an AltoIra account if you’re going to use retirement funds.
- Learn and have fun!
Notice I didn’t include preferences for stages or sectors, as those may only become apparent once you start reviewing and investing.
Overall, I highly encourage angel investing. It can be incredibly financially-rewarding, but as I’ve tried to point out, there are many other reasons to do it, with perhaps the most important one being it’s a lot of fun.
We have nearly 100,000 investors in our funds at Cambria, and many of you ask if you can just “invest alongside my deals” or invest in my syndicate or rolling fund. Hopefully, it will be possible soon, but being a public fund manager has lots and lots of extra requirements and disclosures. You can sign up for my email list to ensure you’ll see the deals if and when I start sharing them. We will have a special announcement coming this summer…
So, stay tuned…
In the meantime, get started on your own and let me know your thoughts. As always, feel free to email me at firstname.lastname@example.org
Here is a list of podcasts we’ve done with angel and VC investors. You can find them all on our YouTube channel here:
Venture Capital & Angel Investing
Episode #149: Phil Haslett, EquityZen, “Lyft’s Doing $2 Billion Dollars A Year In Revenue, And It’s Growing That Revenue 105% A Year. There Are Only 8 Companies Listed On The Stock Exchange In The U.S. With That Kind Of Profile”
And here is startup series where we interview founders (also in a YouTube playlist) :
Episode #243: Startup Series – Doug Ludlow, MainStreet “We’d Like To Be There As America And The World Starts To Rebuild, And Give Tools To These Companies…Access To Capital And Financing In A Way They Wouldn’t Have Had Before”
Here is the full list of companies I’ve invested in that are still alive and kicking (exits excluded):
ATAI Life Sciences
Barn & Willow
Bite Toothpaste Bits
FightCamp (f.k.a Hykso)
Go – X
Good Health Company (GHC)
Higher Ground Education
Osh’s Affordable Pharmaceuticals
Phoenix Molecular Designs
Ready, Set, Food!
Synova Life Sciences
The AI Fleet
Trala: Learn Violin