9 important things which I found out in early stage angel investing

I am amazed that a startup can be valued at a sizable billion dollar valuation, much more than an established multinational.  And yet the startup hasn’t churned a single dollar of profit after years and years of burning cash to chase market shares.

Think of it as a roulette where it spins and spins but never stops.  Well, it may cease to spin once liquidity dries up, once the Investors stop pumping additional funds.  This may happen if we are in a global crisis – remember 2008? 

So here we are, news headlines mentioning ABC Venture Fund invests in startup A.  Therefore, startup A must be a hot potato that has a great potential of 30x return (or more), simply because the big boys are already vested. 

The analogy works similar for a public listed company.  If a substantial shareholder invests into the business, this must be something valuable that THEY know and I don’t. 

Even if the startup doesn’t make a single cent of profit, that’s fine – all we just need is a trade acquisition or better still IPO possibility.  

Then again, how many Grab, Carousel, Tokopedia do we have in this region?   Are we trying to find a needle in the hay and hope one becomes a runway success?

And so, here I am writing down 9 real things which I find particularly fascinating (or you can say, keep your eyes open and ears wide) 

1. Who-funds-who is never a barometer to validate your angel investment 

Often, I hear stories of startup saying Fund A buys into me, Fund B buys into me.  From the startup perspective, that’s understandable because any VC is important to be onboard to boost their reputation and brand name.  However, a VC runs a fund. Another inclusion on the fund won’t make or break the fund performance (the LPs will still be happy) unless the stake is much larger from the total portfolio value which doesn’t really happen.  The fund works on the basis of diversification. So, adding one more to fit into say a total of 50 startups makes sense.  Surely, there will be successes from a few of them – and this will generate a better IRR. 

From an Angel Investor standpoint, one can’t just depend on whoever is onboard only, a screening process is needed since the investment is from a personal capacity – risk is greater.  A VC can be a good validation but not a final decision. Therefore, an Angel Investor should do their own assessment.  Of course if it’s VC closing the round and you have the spare monies to be part of it, well, it’s your call! 

2.  95% of startups are not investment ready 

I get several deal flows; most are trying to fix a problem or making cosmetic changes to reconstruct the problem a BIG problem and they are there to solve it.  Sometimes, there is a reason why the larger corporations don’t dive into it.   It can be margins are too low that doesn’t warrant substantial resources.  Or it isn’t practical to execute and be extremely profitable.

The basis of investing is to make money work harder for you.  And because it’s Angel Investor where risks are extremely high, it’s fair to say that for every $1, the aim is to get at least $30-$50 back.  So, an Angel Investor has to ask – “can this startup opportunity make it?”  No one has a crystal ball, no matter how iron clad the investment criteria framework is – it’s anyone’s guess out there. 

However, the initial conversation with the Founder should give a clue if the man behind the wheel can make this happen.  The overall business model – and the ability to pivot and scale up – is another.  And the expertise to create a real intrinsic business value is another. Another good indication if there is a potential demand in future – then it’s worthy to say it’s “investment ready”. 

For instance, solving a parking problem in Singapore won’t be a global phenomenon.  Having drones are interesting but can you envision drones flying everywhere in warehouses and in shopping malls? Don’t know, certainly not me.  Investment-ready?  Not to my liking and I doubt this will be a reality.  Creating software in a global supply chain to resolve a problem and get a sticky buy-in from corporates - yes, that’s a better call.  

Hence, I tend to be very selective to find the remaining 5%.
Good luck to me! 

3. Startup that is more interested in finding money instead of reinvesting their proceeds

I always like startups that bootstrap from day one.  What this mean is they are mindful of dollars and cents, they may have a tendency to be sensitive to P&L (profit & loss).  Even if they don’t bootstrap and start to raise funding in pre-seed and seed round, that’s completely fine – provided the Angel Investor like myself get a sense that they know about revenue, margins and expenses.  

I won’t expect a startup to make a profit; the first stage is about growing top line yet keeping a check on expenses, about how they earn money through a model that has to be robust over time. 

Any business needs to have someone who is financially aware.  Startups who always dive into the market and search for funding after funding after funding may lead to a tendency of not being financially prudent – in several cases, they die off just like obike case where they run out of cash.  

Caveat here is - if the Angel Investor is able to sell off in Series A to Series B to the big guys in another round of financing and manage to make a tidy profit, at least the Angel Investor benefits. 

Generally, I prefer startups who know how to strike a balance between spending and earning. In other words, if you earn $50, don’t spend $49 and leave $1 for a lollipop!

 

4.  Get at least 10 startups and 1 or 2 should have a high chance to exit  

From my numerous conversations with PEs, VCs and seasoned Angel Investors, although there is no magical number, I feel the recommended number of startups to invest is at least 10.  I heard of others mentioning 20 or 25.  That’s a huge sum of capital to allocate as a newly joined Angel Investor.

Question is, why would I reallocate my portfolio to a higher % to this?  It must never be.  I already have an equity and reits portfolio in public listed markets. And my end goal is to make sure there are recurring proceeds (e.g. dividends) back to me for my retirement days.  

Hence, I’ll stick to 10 – surely one can’t go wrong with all 10 right?  

 

Technically, this means S$250,000 in total, assuming the Angel Investor cuts a cheque of average S$25,000 per deal.   Let’s say one does S$10,000 per deal, this will result in an upfront allocation of S$100,000. Do $15,000 per deal, this will lead to $150,000. 

Imagine if S$10,000 is invested for a post money valuation of US$3 million in pre-seed round.  The Angel Investor gets 0.33% stake, non-dilution with normal terms.  The valuation goes up to US$15 million in next 4 years as revenue tripled and quadrupled.  And the Angel Investor sells his stake to another investor in Series A round.  He will get S$49,500, netting a profit of $39,500.  

What this means is early stage angel investment is mainly about capital gains.  

To go direct for every deal (only equity-based, no SAFE, no convertible note) equates to more risk taken as more capital is required.  Therefore, I think it’s worthwhile to have a mix of direct, syndicate and crowdfunding (equity).  If I do 10, this means 8 syndicate + crowdfunding and 2 direct.  I’ll take a little pit-stop to review once I reach to 5 startups.  

5.  Develop your own investment framework  

Truth be told – startups have to sell you a sexy story.  As an Angel Investor, I have to cut through the fog and assess whether this idea can be a reality with a huge market that is prepared to pay for the product and service.  To do this consistently, I have actually developed a 2-pronged approach. 

The first is a weighted scorecard to check if they get a “pass”.  If they do, I will go to the second stage and have another series of in-depth questions to ask around the Founder, check-in the business model, evaluate the financials, understand the future growth path, envision their exit plan, validate their structure and the cap table.   

It also depends on the bite-sized that I am willing to participate in the investment which warrants the amount of time and effort needed.

6. Majority of your investment consideration is about the Founders 

Once you have submitted your cheque, even though you are protected by “Information Rights” as indicated in the shareholder’s agreement, there is a chance the startup will turn the table around and not keep you updated.  After all, Angel Investor can also be considered a minority shareholder but plays an important part in the early stage.  I can pen down a number of things here but the general onus here is to trust the Founders.   

How to do this?  Have an evaluation criteria.  

For my investment framework, I have placed 65% score on Founders.  Out of 65%, I have dissected specific % to team, vision, motivation, personal attributes, business acumen, critical thinking etc….assessment is done through multiple questioning and conversations with them.  It’s not an interrogation but a semi-professional way to get deeper insights.

It’s not a 100% foolproof method, still a great approach to make me better informed.  Actually, it’s also a skill set to learn how to size up people earlier from a corporate perspective, a trait needed during the phase of any business negotiation!

 

7.  It’s easy to enter, hard to exit

 

Don’t get me wrong, there is a chance to exit.  But it’s never easy to liquidate your shares due to low liquidity and longer lock-in period (average 7 years, some take 10 years).  Also, VCs may not be interested to buy out an Angel Investor’s shares.  New Angel Investor has to understand this.

Leaving you to turn to existing individual shareholders through ROFR. (rights of first refusal)  

If it’s through equity crowdfunding, it’s a good chance other investors are willing to buy your stake but don’t expect a higher valuation unless the startup is highly sought after. Post ROFR, it will be to other investors whom you know and are keen to buy your shares. IPO is a rarity.  Henceforth, the best way to exit is via a trade sale.   

Therefore, I will assess whether the startup operates in a niched segment, a highly differentiated category that complements with other companies’ line of businesses.  For instance, if startup A says their exit plan is via a buyout from company A, I will ask “why do you think company A will buy you 7 years from now?” Another interpretation of this is “what deep value you create that company A WILL buy you?”

So, it’s not easy to get an exit unlike the public listed market but there is a chance for acquisition by the bigger corporations, provided the Angel Investor understands how it works.

8.  Too much hype. Invest mainly in your circle of competence

Cryptocurrencies, blockchain sounds like the next big thing.  Honestly, I do not know.  I take a sweeping view of it and find that yes – it’s intriguing but is it really for me, as an Angel Investor?  How much do I know and thus, able to draw out a roadmap that lead to a probable business success?  Or is it for the bigger VCs who operates a diversified fund?  Too many “if’s”…..

I prefer to take a breather here.  Thus, I choose startups that operate in my circle of competence which is FMCG, retail and e-commerce and data intelligence.   Sometimes, an odd ball that pops up may also catch my attention.  For instance, an innovative AI-driven platform in grocery e-commerce that is proprietary.  In summary, anything falls outside my realm of knowledge such that it’s complicated or things that I can’t even explain in a sentence won’t be in my investment radar. 

9. Investment terms in the term sheet

I picked up 2 books to read on venture capital, went for a legal masterclass (thanks guys!) to learnt about how deal terms are negotiated and made.  For instance, drag-along rights to liquidation preference.  If one is a new Angel Investor and has not worked in the private equity/fund management space, it’s better to gain deep knowledge on this, so that you have a broad understanding.  One can get a legal firm to draft out but it’s always good to know your rights and obligations.  Other administrative matters include set-up, maintenance and liquidating the SPV (if you are a Lead Investor, you need to know the mechanics)

I hope the above provides an introductory overview of things around angel investing.  In my later posts I will write about how an Angel Investor analyses the business value of a startup. 

p.s.
And you, as a reader will ask me – “why then do I invest in startup”?   It’s not just investment, value adding is another.  I can lend my expertise in industry knowhow, mentorship in regional business development and market penetration, to open up new network access and be part of the grand scheme of things, as a cheerleader (i.e. investor) of course.  It’s the satisfaction of working closely with the startup to build something bigger – and get financially rewarded through capital gains.