How to Become an Angel Investor

As our local tech community grows in prominence, it is starting to attract interest from individuals who to this point have not invested in startups.  I have been asked by a number of people recently how they can become an Angel investor.  Putting aside the obvious answer – to become an Angel investor you need to make an investment – I have been having this conversation enough that I thought it made sense to set some thoughts out in a blog post.

If you are considering being an Angel investor in startups, here are some things to think about.

You Should Appreciate the Historical Definition of Angel Investor

The term itself creates some confusion.  Angel is a term that carries with it a semantic meaning that is positive and carries attributes such as protectiveness, selflessness and higher ideals.  The use of Angel as an investor term originates with Broadway shows, and the “Broadway Angels” that provided investment capital so “the show could go on.”  Anyone who has been in the entertainment industry knows that most shows lose money.  But, that didn’t bother Broadway Angels – they invested to promote the art form, rather than merely to make money.

Carrying this forward, we use the term Angel investor to describe individuals that invest in startups.  Because the term carries implied characteristics, someone who is preparing to become an Angel investor should understand that from an entrepreneur’s perspective Angel investors are expected to be easier to deal with, and less motivated by investment return than a professional investor like a VC or hedge fund manager.

Although the Term is Narrow – the Range of Angel Types is Very Broad

The reality is that Angels come in all types.  Some are all about the money, and some are more interested in mentoring.  Some Angels make one investment in a year, and others make 10. I have seen Angels that were sophisticated and approached investing as a professional activity, and some that worried little about legal formalities or close investigation of an investment opportunity.  The diversity in approach really allows each Angel investor to make decisions about what is “in it for them.”  The most common motivations among Angel investors are:

  • To make money
  • To be involved in new businesses
  • To be a mentor and guide
  • To promote their own business

There are gradations in each of these categories, and Angels combine these motivations and weight them in different ways.  The most important thing, however, is for the Angel investor to have clarity on his personal motivations.  This is essential because the best Angel investors (for their own and the startup’s perspective) have a consistent approach. Consistency allows the Angel investor to have guiding principles that she can rely on when things get difficult with a startup (which happens frequently), and gives the entrepreneur who is considering taking money from the Angel some ability to assess whether the tradeoff of the deal makes sense.  For example, if an Angel is motivated primarily by investment return, the entrepreneur should know that if he is looking for an Angel investor who wants to be a mentor or guide.

You Really Should Be Wealthy

The regulatory environment that facilitates investments in startups works much more efficiency when an Angel is an “accredited investor.”  Simply put, an Angel should have more than $1M in net worth, or an annual income in excess of $200K.  It is difficult for startups to sell investments to individuals who are not accredited investors.

Additionally, from an Angel perspective it is better to be wealthy for a number of important reasons:

  • Portfolio reasons – generally it’s not good investment diversification to have more than 5 to 10% of one’s investment capital in highly speculative investments.
  • Risk management – investing in startups is risky.  If you can’t afford to lose the money you probably shouldn’t invest in a startup.
  • Startup investing is best done as a portfolio approach.  It is much smarter to spread $100K around 5 companies than to invest in one.  Even the smartest startup investor acknowledges that there is luck involved in startup success.  The best way to describe good startup investing is that you make highly skilled guesses in order to be in a position to be lucky.
  • The outcome is highly variable.  Angel investing is unlikely to be a significant wealth creation opportunity without a bit of luck and a great deal of focus.  It should be done with balanced expectations.  If you want to make money as an early stage investor you will need to take significant time and become a professional, or you should invest in startups through a professional manager.

You Should Invest in What You Know

Ideally, you should invest in what you know or understand for two important reasons.  Firstly, if you invest in something you understand, then you will more likely be able to make a skilled and informed investment decision.  Secondly, startup entrepreneurs expect their interactions with their Angel investors to be positive, so that if you have contacts or expertise to bring with your money the overall investment experience will be better for all involved.

If you want to invest in businesses that you do not understand (and you do not want to utilize a professional manager), then you should associate yourself with other Angel investors with expertise.  You can find this either through networking or by joining an Angel group (more on that below).

Finding Good Deals is the Key

When startups raise money a natural tiering occurs.  If they are informed about a market, entrepreneurs raising capital tend to go to the investors that they think will provide the largest benefit to the company. For example, they look to investors that have a reputation for “knowing a good deal” or seek out investors that are known to “write big checks without much diligence.”  It is absolutely true that a compelling startup rarely has to look as hard for capital.  Investors tend to be attuned to opportunities and momentum, so that when a startup creates a buzz, the fundraising tends to go well.  What this means for any Angel is that he wants to be among the first to be called for a new deal, and not the last.  As a new Angel it is very difficult to be the first call (unless your last startup netted your $100M of course, in which case the only calls you will get more of than from entrepreneurs will be from wealth managers and jet charter companies).  Therefore, a new Angel’s best course of action is to find a way to be part of an existing Angel group or deal flow aggregator to see new things early.  The alternatives I most recommend are:

  • Look at Angel List.  Before starting off on the path of being an Angel investor, take a few months and get a sense of who are the investors in your locality that invest in companies that interest you.  See which of them appear to create momentum for the companies.  Then either try to meet with them and become a co-investor, or perhaps consider investing directly in companies that these key Angels validate.
  • Join a local Angel group.  Not all Angel groups are the same.  Some are loose affiliations, and others are highly structured.  These days it is rare for an Angel group to require each member to invest in a deal that is shown to the group, so individuals retain the ability to opt in or out.  Some groups charge an annual fee for deal flow, and the more centrally managed ones will require you to pay a portion of your profits to the manager (as you would for a professionally managed investment).  The most important thing is to be part of a group that is well respected and gets to see deals first.  If you ask around, you’ll rapidly find out which groups are the best regarded.  In GWR there are many Angel groups available, among the longest operating are various groups managed by John May, the UMD Dingman Angels and Blu Ventures.
  • Frequent places where entrepreneurs linger.  There are places in any region where entrepreneurs frequent.  Often the best time to see a deal is before the entrepreneur is looking for capital.  If you give an entrepreneur half a chance she’ll tell you about her latest idea.  This is more time consuming than joining a group, but can often be more rewarding both financially and psychologically.  It is also a way to start to develop an individual reputation so that entrepreneurs know where to find you.  Frankly, the goal for any Angel investor who wants to make investing more than a hobby is to become widely known as a friend and confidant to entrepreneurs.  There is no substitute for investing time into the community. Entrepreneurs talk and value authenticity.  Good places to start in the Greater Washington Region are the entrepreneurship programs at our local universities (particularly Mason, GWU and UMD), as well as community efforts such as DC Meetup, DC Entrepreneur Week, Foster.ly, Distilled Intelligence,  and StartupDC/VA/MD.
  • Get to know the professional investors.  At times professionally managed early stage funds will have deals that they like but are too early for them, or will have room in their investment syndicate for co-investors that they like, or believe can add value to their portfolio companies. Local funds like Amplifier Ventures, Fortify.vc, GAP Fund, New Atlantic, Grotech, True Ventures and Valhalla will often allow Angel investors to co-invest in their financing rounds.  Professional investors often raise money from Angels, so investing in a venture fund is often a way to get the benefit of a professional management as well as opportunities to make additional investments on deals that the Angel particular likes.

Have a Sense of Humor

Startups are easily the most engaging and dynamic activity that most of us will ever experience.  The ups and downs of startup life as both an entrepreneur and investor are surprisingly often and surprisingly extreme. There is no halfway in a startup.  If you can’t embrace an extreme level of ambiguity, or enjoy it in some weird way, you probably shouldn’t invest in startups at all.  The fun of startups is the randomness and path to discovery.  If the journey itself doesn’t truly engage you, then you will probably find Angel investing disruptive and upsetting.

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