The Perils of Angel Investing

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You’re reading an excerpt of Angel Investing: Start to Finish, a book by Joe Wallin and Pete Baltaxe. It is the most comprehensive practical and legal guide available, written to help investors and entrepreneurs avoid making expensive mistakes. Purchase the book to support the authors and the ad-free Holloway reading experience. You get instant digital access, commentary and future updates, and a high-quality PDF download.

The Perils of Angel Investing

Angel investing can be challenging for a number of reasons. It can be time consuming and may require you to quickly come up to speed on industries or technologies you know little about. It can involve negotiating investment terms and dealing with unfamiliar legal issues. Additionally, once you invest you may have very little insight into what is happening to your investment and very little (if any) control over what the company does. You will also be impacted by the rights and valuations the company negotiates with any follow-on investors, which can have a dramatic impact on your return. The goal of this book in part is to help you understand the legal issues, deal terms, rights, and limited controls that will have an impact on your outcomes. Ultimately an angel investment is a gamble, and your goal is to try to increase your odds of winning before you place your bet.

Time Commitment

Angel investing can be time consuming if you are actively involved in selecting your investments. A typical active angel investor may see 50–100 investment opportunities in a year. They attend angel group meetings, meet with individual entrepreneurs who reach out to them, and see deals from within their network of other angels. They may be interested enough to look into ten of those deals and engage in serious due diligence on a handful or more. On the deals they decide to move forward with, they will spend time negotiating terms and reviewing legal documents. All that work might result in three or four investments in a year.

Your degree of involvement and time commitment is up to you, especially if you are part of an angel group (formal or informal) where members split up a lot of the work. So while it is possible to take a “free rider” approach and jump in on deals someone else recommends and has negotiated, your colleagues may eventually ask you to share some of the workload.

As an angel investor you will get a lot of requests from entrepreneurs who are beginning their fundraising journey. And once you have some investments, you might make time to meet occasionally with the entrepreneurs you’re backing and respond to requests for advice or introductions to potential customers or follow-on investors. If meeting with entrepreneurs (think long hours in coffee shops) and doing due diligence sounds fun and exciting, then you will enjoy the time you commit to angel investing. If you are really committed, you can aspire to be a lead investor, which can be quite time consuming and might enable you to sit on the board of the startup (more time commitment), which has its own set of perils and rewards.

importantEvery angel investor’s situation is different. Some are retired or semi-retired, and angel investing is a great hobby and source of social engagement for them. Other angels are working full-time and have families and other commitments, but can fit in angel group or diligence meetings when they come up. Necessarily, they will be less involved. But the nature of the startup world—where founders are often working days, nights, and weekends on their companies—means you’ll likely be able to fit in founder meetings and other angel investing responsibilities outside of your normal work hours.

Lack of Liquidity

cautionIn general, you should think of your angel investments as almost always completely illiquid, meaning you should not expect to be able to sell your convertible note or your restricted shares to get your money out unless there is some sort of liquidity event. Sometimes a secondary market for a company’s stock develops before an IPO, but this is rare. By definition, angel investors are putting in their money very early in a company’s life, and it will typically take five to eight years or more for the company to see a liquidity event;** even then, the company may be acquired by another private company whose shares could also not be sold for cash in a public market. It is possible to have an investment return a profit within a year or two through an acquisition by a public company, but that case is an exception.

Future Rounds

The terms of the follow-on rounds of investment have a big impact on your investment outcome and can determine to a large extent whether you make a lot of money or none on your angel investment. We will cover the deal terms that you can use to influence how follow-on rounds may affect your investment.

Financial Risk

The SEC rules exist to protect consumers by trying to ensure that the investor is financially savvy enough to broadly understand the implications of investing in private equity, and that they can afford to lose the investment.

important To the latter point, you must be able to afford to lose your entire investment! To be a successful angel investor, you should build a portfolio of investments over time and be able to afford to see those investments fail—hoping that the success of one or more investments outweighs the losses on the rest. Ideally, you are placing multiple educated bets and hoping you hit the jackpot.

danger Angel investing can be a great portfolio diversification strategy (in addition to more liquid assets like public stocks and bonds and real estate), but it should not be your retirement strategy.

This book is designed to make sure you deeply understand the terms and implications of your investment in addition to helping you be selective about those investments. But people without a high appetite for risk will find that angel investing isn’t for them. The thrill of the risk should be a draw to you.

Joining an Angel Group

There are a number of reasons it is beneficial to join an angel investing group.

An angel investing group (or angel group) is a syndicate of angel investors that collaborate on deals. These groups can be large and formal (like Seattle’s Alliance of Angels, which has over 140 members as of this writing), or small and informal (especially when not based in a major metropolitan area). They can help green investors learn the ropes of angel investing, improve access to deals, and share the work and potential costs of due diligence and negotiations.

There are over 400 angel groups spread across the U.S. and Canada according to the Angel Capital Association, which maintains a directory on its website. You might also be interested in the Angel Capital Association’s FAQs About Angel Groups.

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