First, be sure that there is no such thing as low risk and high return. They always go hand in hand. And I have to mention portfolio management again as a way to mitigate risk. LPs naturally create portfolios by investing in funds, so let’s stick first with angel investors only.
There is not enough easy readings for angels, but one book is definitely worth reading for every starting angel investor. “Angel: How to Invest in Technology Startups–Timeless Advice from an Angel Investor Who Turned $100,000 into $100,000,000” by Jason Calacanis. Some things he mentioned are history now (Silicon Valley is not The only place to invest any more), but principles are still valid. I will use examples from his book.
Jason hit three unicorns in his first 50 investments. Quite astonishing. Some were even decacorns like Uber, multiplying his initial investments by roughly 1.000 times. Yes, 100x or 1.000 times your money is the size of success when your portfolio company reaches the unicorn valuation. But the chances are you never hit a unicorn. Statistically, only 2% of start-ups reach the 1 billion valuation. Probably even less in Europe. So you have to invest in 50 (good) companies to have a good probability of catching some unicorn. Trust me. There is absolutely no way you can spot and recognize a unicorn in the early stages. You may notice some signs that the founder has potential. But so many things can go wrong. I beg you, don’t do just 2-3 bets and hope for a huge outcome. It would be pure roulette, while investing is rather poker, where you play with your cards and face.
The probability of hitting unicorns is not high. On the other hand, if you invest wisely, the probability of losing all your money is even lower. Let’s say you invest 10% of your fortune, free money for investment. You probably can afford to lose it, don’t you? Now, If you are lucky in your investments, you reach 10x on your portfolio. Which means you double your fortune.
Make your investments with that mindset. You are playing a venture game. You are not risking your live. You can afford to lose the money you invest.Don’t waste your time with safe bets. All great companies seem to be an obvious investment when they are successful. But in the beginning, they probably looked like a silly, risky bet. Most investors refused to invest. Do you see a potential for the company to grow by a thousandfold? Then, consider the investment. Do you see it growing three times? Forget it, even if it looks safe. Don’t take me wrong; it can still be a very good investment. But not with the money you have dedicated yourself to venture investing.
In the end, you will lose most of your portfolio, and the remaining companies will bring you less than you would expect. I will show you some portfolio simulations later. But first, I would like to explain one thing that not everybody understands: dilution. As an angel investor, you invest early, in pre-seed or even inception. When a company grows, more investors will come, and your share will be diluted. Here is a sample calculation:
Your share in the company decreases over time, but your value grows. If you don’t want to be diluted, you must participate in your portion of every investment round. Most angels don’t do it.
In the current market conditions, we see a trend of companies exiting after series A. Entirely (M&A) or partly, in the form of secondaries for some early-stage investors and founders. It makes sense. Angels sell about 1/3 of their shares and get back their money plus some profit. And they can keep the rest of the shares if they want. The overall multiple is lower; on the other hand, they don’t have to wait so long. Becausepatience is crucial for start-up investors. It takes more than ten years to get to an IPO.
Now, let’s have a look at how your portfolio could look if you are not happy. Your investment money is 2M, and you invest 10% in a venture. Over time, you invest 200k in 50 start-ups. You write off 70% of start-ups, which is a good 35 investments. From the remaining 15 companies, 6 return the investment, 5 double it, 2 make 5x, one brings 10x, and one makes 20x. Really, not astonishing results. But it returns you 224k, your investment plus 12%.
In other words, Jason Calacanis says that if you invest in a large enough portfolio, you arehighly likely to get at least your money back. And if your best company doesn’t bring you 20x but 500x, you double your entire fortune. This is just an illustration of how risky start-up investment is. It is risky and must be treated as such, but it can be rewarding.
I can tell you that making 50 investments is a hell of the work. I mean, real investments, not just bets. But if you dedicate five years, you can definitely make it. It is ten investments per year. It gives you an opportunity to learn from others or from your mistakes. You just need to dedicate quite a lot of time to it. Invest with risk, conviction, and discipline. Invest in founders when you believe they can make it, even if it seems risky. But be disciplined, always invest your ticket. Don’t fall in love and make a large bet on one founder. And as I mentioned previously, you must enjoy it. And if you enjoy it, you will be rewarded.
Petr Sima, Founder and Partner @ DEPO Ventures | EBAN board member
