Angel investing, or private investing in startup companies, is one of the riskiest financial asset classes.
Several angel investors, however, have “cracked the code” for realizing an average of 27 percent ROI, according to the 2007 Returns to Angel Investors in Groups study by the Angel Capital Education Foundation. Here are tips for creating a healthy portfolio of startup companies:
A portfolio for a reason
Many novice investors become discouraged — believing they can invest in only three companies to achieve success, and are dismayed when all three go bankrupt. If you don’t select two or three companies in a public stock portfolio, why would you assume that diversity isn’t required in a private stock portfolio, an asset class 10-20 times more risky?
Experts debate the effective number of companies in a portfolio, targets range from 15 to as many as 60 companies. I believe an optimum number can be in the range of 18–25. But if you take the “throw spaghetti at the wall and see what sticks” approach, 60-plus is a good target number. If you source the deal flow and perform due diligence, 18 could be a healthy target.
Source the best of the best
In 2016, angel investors funded 73,000 new companies, according to the Center for Venture Research. How do you find the best of the best? It requires time and energy.
You must proactively source from universities, incubators, startup competitions, accelerators, attorneys, accountants, friends, etc. It helps to join an angel network where members “divide and conquer” to share the load. If you source alone, you need many contacts and relationships to help uncover extraordinary opportunities.
Comprehensive due diligence
Due diligence mitigates risk. It doesn’t eliminate risk; it mitigates risk. At BlueTree, we use the National Venture Capital Association due diligence checklist. This comprehensive, inclusive checklist is a four-page summary of items that evaluate execution risk, market risk, technical risk, environmental risk, business timing risk, business documents/structure risk, financial risk, etc.
Portfolios with 40-plus hours of due diligence achieved returns five times higher than those with 20 hours or less of due diligence, according to the Returns to Angel Investors in Groups study.
Buy low, sell high
Yes, price applies to this asset class and is most critical at the early stages.
Angel investors typically assume the highest risk (after friends and family), and you should be rewarded for this, especially when additional rounds of funding will dilute an early investors’ equity ownership.
As a side note, BlueTree’s experience demonstrates that investors who continue to invest in additional rounds to preserve their ownership tend to experience higher average returns.
Use your connections
If you introduce the startup company to suppliers, vendors, distributors, mentors, and/or advisers, this too can add to your portfolio’s success. Of course, do this with restraint — interrupting constantly with phone calls and office visits impedes the company’s focus.
More nuanced success factors can impact angel investor returns, but these fundamentals will help the novice investor create a foundation for healthier returns.
Catherine V. Mott is CEO and founder of BlueTree Capital Group, BlueTree Venture Fund and BlueTree Allied Angels located in Western Pennsylvania. As one of the more than 370 professional managed private investor networks in the U.S. and Canada, BlueTree Allied Angels has invested more than $27 million in 43 regional startup companies.