As the head of Angel Investment Network, I’ve had the chance to speak with a lot of angels over the years. When discussing their experiences, some things kept coming up again and again…
1) Not looking at enough deals
Make sure you look at as many investment opportunities as possible. The more business plans you read, the more likely you are to find the one that pushes all the right buttons. It also lets you notice industry trends and see if any competitors and emerging. Last year I read about 50 plans about wind turbines, who all claimed to be the best. You quickly realize that there are so many new players fighting for market share that it would be a very difficult call to make in terms of making an investment. Professional venture capitalists expect to look at 100 companies for every investment they make, so you should join several angel groups to make sure you see as many deals as possible.
2) Not making enough investments
The Rule of 12 says that you need to invest in 12 companies to have statistical diversity. Invest in fewer than 12 deals and you run the risk of them all failing. Investing in a startup is very high risk, so it’s much more advisable to invest £20,000 in 5 companies than £100,000 in one company. Ron Conway says 1/3 of the startups in your portfolio will lose, 1/3 will get you your money back and 1/3 will be wins. This shows how important it is to diversify your portfolio as much as possible to increase your chances of picking a hit.
3) Not knowing when to quit
I don’t want to make too close a comparison to gambling, but angels need to have the same mentality as gamblers when things don’t go well. In the same way that a gambler needs to know when to walk out of the casino when things aren’t going their way, an angel needs to know when to throw in the towel and let an investment go out of business.
4) Expecting a quick return
Most entrepreneurs’ business plans say they expect to exit within 3-4 years, but the reality is that it usually takes much longer than that. Angel investing is a long-term commitment, so it’s important to invest money that you can afford to be without for a number of years.
5) Not doing thorough due diligence.
As with any business deal, it’s important to do through due diligence on the business and management team. You’ll more than likely be giving your money to a complete stranger so you need to trust them completely and feel comfortable that they’ll spend your money wisely.
6) Not reserving additional capital for the inevitable follow-on round.
The initial investment won’t last forever and most companies will have to raise more capital (either from existing investors, external angels or VC’s). If you invest in the next round of funding, it’s easier for you to set the company valuation. By participating in the follow-on round, the entrepreneur can go to the VC’s and say we’ve already raised X in this round in return for Y% equity, which values the company at Z. If not, you essentially lose control in that round and the VC’s are in a very strong position to dictate the terms of the deal.
7) Following a herd mentality
A lot of investors like to invest in groups as they get the added benefit of other investors’ expertise, contacts, etc. They feel their pooled experience should give the company (and therefore their own investment). This is often the case, but I’d remind investors not to place too much trust in other angels’ judgement and to always do their own diligence and research.
There are many ways to avoid these common pitfalls. Joining an angel network is a good way to see more potential investment opportunities, build a portfolio, and find out about other angels’ experience with investing (you may be able to learn from their mistakes).
Investors, are there any other mistakes you’ve made over the years? Add your thoughts below so other angels can have a much better shot at taking advantage of the great potential returns start-ups can provide.