Startup Investment Strategies for Angel Investors

Ben Lim Investments, Investors 3 Comments

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Startup Angel Investor Investment Strategies

Here I will highlight the many real reasons angel investors join us, as well as explain startup investment strategies that are broken into 2 categories – risk management and value creation. Before we get into angel investor investment strategies, let’s look at why we got into startup angel investment.

Why Startup Angel Investment

There are many reasons why investors join us. Some investors want a challenge in life by helping founders solve huge problems. Some want to give back to the entrepreneurial community by guiding new entrepreneurs. Some want to increase their investment prowess by learning from other great investors. But none are in it purely to make a quick buck.

Non-Monetary Reasons for Angel Investing

Our investors are sophisticated and are not chasing after money anymore. In a weird way, money chases after them. They have proven themselves successful in life. Now, they are pursuing the top level of Maslow’s Hierarchy of Needs – where they are now pursuing their inner talent and creativity fulfilment (in other words, to do what makes them happy).

maslows angel investment malaysia

Monetary Reasons for Angel Investment

Angel Investors know that wealth preservation is one thing, and that wealth creation is another matter. To preserve wealth, it is all about hedging against inflation plus generating enough passive income to sustain one’s lifestyle. 

To create more wealth, the usual safe & conservative investments won’t be able to do the job well. This is where high risk, high return investments like startup or angel investment comes in. 

Here are the aggregate numbers of angel investing for those who want to test their investment skills:

startup investment strategy numbers

20-25% Annual Return is the average over 5-7 years, for a total of 2.5X capital returns average (US statistics). Compared to other asset classes, Stocks give an average of 6-7%, and 3-4% for Fixed Deposits (varies across countries). This makes startups an asset class that is perfect for the high-risk portion of an investment portfolio. It is generally recommended that it be no more than 5-10% of a high net worth individuals’ net worth

Angel Investment also gives investors much more control and transparency vs. investing into VC funds. You get to choose what you invest in, learn more about businesses, and via mentoring, learn a lot more about business from a different perspective. There is also less cost vs the typical 2% annual fees (on initial investment) and 20% carry fee (on exits) that VCs typically charge. That adds up to a huge percentage considering fund terms are typically 5-7 years.

Risk Control – Angel Investor Investment Strategies

Spray and Pray Investment Strategy

If you’ve heard about 500 Startups, they are popular among the industry for employing this strategy. They invest in anything and everything where they see potential. They take it as a numbers game (luck or probability, however one can see it) betting that the successful startup exits will cover all the money-losing startups, plus give a good return. While the math does work out, it depends on successful startups churning out a minimum 50X return (more if they are lucky), and 10% of the portfolio hitting these return numbers. This strategy also depends on getting back money from startups that are not dead, and are able to pay back some of the investment.

500 Startups’ Dave McClure on portfolio diversification and the return opportunities of “spray and pray”

Portfolio Diversification Investment Strategy

startup portfolio diversification strategy

In all asset classes, diversification is a must-do strategy – be it stocks or bonds or property. Having all your eggs in one basket is never a good idea, as Warren Buffet himself said so.

Diversification is surely needed in startup investment, but over-diversification can also be bad as it reduces the average returns as you diversify more. However, it does get you closer to the 25% average returns! By diversifying just enough, an investor is more likely to hit a big one. Typically we advise our angel investors to invest in 10-20 startups to have a reasonable chance of hitting a big one. Depending on your portfolio size, it may or may not make sense to invest in more than 20. For example, if the minimum you can invest is $10K in general, then you will find it hard to split to more than 20 startups if you’ve allocated $200k to invest into startups.

https://blog.crowdfunder.com/angel-investor-insights-diversifying-your-startup-portfolio/

 

Startup Selection or Evaluation Strategy

Startup Selection can be a tough one if you are a solo angel investor. Joining an angel investor network will definitely help you gain better access to quality startup deals. 

A good methodology for startup selection is developed over time. It is beyond just evaluating the problem, solution, market, product, traction and financials. The timing of the industry and the valuations also matter. More importantly, the founding team and your ability to add value matters more. 

  1. Startup Problem, solution & market – These are interrelated. Basically, the goal is to ensure that there is a market for the product large enough for you to make back your money. Generally, an addressable and acquirable potential market size of >30X their current valuation (by this startup alone) is the minimum to ensure a good potential of returns. The product must soon (or already) be solving problems that are so painful that people are willing to pay for it.
  2. Startup Traction & Financials –  This is an important one among angel investor investment strategies. Traction is one of the more reliable facts you have that the team can perform. Startups that do not show good traction for their stage (e.g. >30% month on month revenue growth for a startup worth >1M depending on the nature of the startup) may not be worthwhile, as they might not be able to compound value fast enough for desired returns. Their fundraising strategy and well-managed financials are also key to ensuring a relatively strong and stable growth startup. 
  3. Startup Investment Timing – Getting into a very hot startup investment trend is like buying a stock when the stock market is hot. You are likely to be paying a premium over the intrinsic value of the startup. Therefore, it is important to find the right timing to buy into a Startup. An idea alone is never worth >1M, and yet we see many investors getting into idea stage startups at 20M valuations. This means that for those investors, they would have to bank that the startup is worth 1B for decent >30X potential returns (this is after estimated dilution effects). Out of 1.2M companies in Malaysia, 190 are worth more than 1B (that’s 1 in 6250 companies). Very low probability of success can be expected, considering many of these large companies are built over many more years than we can expect a Startup to be of this worth. If you were to get into an idea stage startup at 1M valuation, however, you only need to have it worth about 50M for the same amount of potential returns (1 in 1528 companies). That’s 4X more likely to happen. Of course, the above assumes the one golden startup. The rest may return 0-5X even though they all should have a potential of >30X returns. 
  4. Founding team & the Angel Investors ability to Create Value – The founding team should be amazingly resourceful problem solvers. They should be driven with grit – never to give up when things go south. This is because running a business is one of the toughest things a person can do. That, coupled with the angel investors’ abilities to create value is an impeccable combination. We have seen our angel investors help startups boost revenues many times over. We have also seen their network chip in out of goodwill to help the Startups access the broader market and to create strong & valuable partnerships. Our startup mentors’ knowledge has helped the startup founders avoid huge mistakes, and have also helped them solve hugely painful problems and scenarios. That includes the startup’s journey of almost going bust to being back on track.

Investor Group Investment Strategy

Joining an angel investment group or network has many benefits. You learn more from each other. You get more deals and better deals at that. You have access to more expertise among each other – allowing the startup to benefit more from investors’ knowledge. This often creates value, as I will explain in the next section below.

There are many types of angel investment groups;

  1. Traditional Angel Investor Groups – Angel Investors/friends gather to invest deal by deal. Usually one of them leads the deals, and hence fees might be charged to compensate this person. Depending on the lead investor, it can be management fees or carry fees or both.
  2. Organised Angel Investment Groups – Nexea Angels is an organised group. We have Venture Partners that take a full-time role to ensure (some of our offerings):
    1. More deals, and more quality deals – done through strict startup evaluation processes and proper negotiations.
    2. Paperwork is taken care of – from term sheets, share certs, legal documents, and reporting, we handle all of it in a structured manner.
    3. Mentoring/Support Structure – to ensure all startups are able to connect and benefit from angel investors, for proper startup value creation to take place.
    4. Complimentary services – we ensure any additional needs are taken care of – across legal, finance, strategic partnerships, and technology development. This is to also ensure value creation happens. We do not charge fees for this – but we do take some equity instead of fees as we feel the cash is better used for startup growth.
  3. Online Investment Groups – not fully developed in Asia (yet), most of them are crowdfunding platforms. The issue is the investors rarely meet up, and the amounts are small – so they are mostly retail investors. Crowdfunding platforms charge a fee between 5-10% (of capital raised) to the startups depending on the country (which is really investors’ money). A growing issue is that most smaller investors are unable to negotiate directly with the startups.

http://www.investopedia.com/articles/personal-finance/060415/how-join-angel-investor-group.asp

Value Creation – Angel Investor Investment Strategies

Mentoring & Guiding

The best mentors create value by 80% listening and 20% sharing. We have seen mentors guide startups to find their own solutions – and this might just be the best way to do it. When asked why the mentor said he will never understand as much as the founder what problem they are facing. Of course, the experience is still shared from mentor to mentee – but every situation is different. 

So, how does it actually create value?

Mentoring, being a very complex art form, is able to give founders clarity when needed. Founders have to make a huge number of hard decisions in their lifetime, and sometimes it can be quite lonely and confusing. That is why at Nexea, we gather actual successful businessmen to mentor the new generation of entrepreneurs. Only they can understand what problems and pain these founders are going through. Therefore, the chances that they are able to successfully guide founders is much higher. We have seen our mentors guide startups out of problem after problem. Problems that if left unsolved, would have left startups dead in the water.

Value Creation

Some other investors introduce their startups to their networks that can help. Recently, one of our lead investors brought in a large company ready to pump in business >30X their current revenues. Another investor of ours introduced a company that is interested in acquiring a startup. We also have had investors make introductions for startups to merge to immediately transform from 2 local startups to a regional startup. That is all in the realm of value creation.

End of Angel Investor Investment Strategies

Let us know if you agree/disagree with the strategies above. If you have another strategy, even better! Let me know and I will include it above.

If you are an Investor looking to help startups in any form, do get in touch! 

https://www.nexeaangels.com/startup-investor-network/

 

  • Let me know if you have any questions about angel investing!

    • Leap Gan

      Hi Ben,
      Is there a chance to get funding for mining industries in Malaysia?
      Would like to get in touch with you to discuss.

      Leap Gan.