To use this site you need to think like an Angel.
Angel investors are usually entrepreneurs or retired businesspersons who have exited their businesses or high net worth individuals. They enjoy working with entrepreneurs and view angel investing as “give-back,” as appreciation to those who mentored them in their early days in business. Angels invest both their time and their money in new ventures. They have a variety of motivations and are not simply investing in early stage companies for return on investment. Angels enjoy mentoring and coaching entrepreneurs and especially assisting in the growth and success of their portfolio companies.
Venture capitalists (VCs) invest other people’s money in early-stage growth companies. VCs are smart businesspersons who raise substantial amounts of money and invest those monies in growth ventures. A single venture fund is usually designed to have a life of ten years with the possibility of extending the fund life for a few years thereafter. Consequently, fund monies are invested in the first three years and investments are harvested three to ten years later.
The general partners of venture capital firms usually invest only 1% of the capital under management with the rest coming from the limited partners. The general partners charge the funds raised an annual administrative fee of 2-3% to operate the fund (facilities, salaries, etc.) plus a 20% “carried interest.” Carried interest is VCs’ share of the earnings of the fund, after the capital is returned to the limited partners. With only 1% of monies invested, you can see that VCs have a huge upside potential for successful funds, splitting the earnings of the fund 20:80 with the limited partner investors, after the capital is returned to those investors.
Angels typically invest in companies for which they have some familiarity with the industry segment (business vertical) where the companies operate. Angels are normally the first funding the company receives after monies from the entrepreneur’s personal accounts, friends and family are exhausted. This seed and startup funding is usually invested by purchasing ownership in the company (equity) and is not a loan (or debt). Investors expect the value of their investment to increase with that of the entrepreneurs. Individual angels typically invest $25,000 to $100,000 per round of investment, with 6-15 or more angels, making up a round of investment of $200,000 to $1 million.
Seed rounds of investment are usually made in entrepreneurs and their companies at a stage when a product has been developed (or has been prototyped) and after a customer or two have been identified who will buy the product. The management team is usually incomplete and the companies are normally at the pre-revenue stage.
Angels invest their own money, while VCs invest the monies of their limited partners. VCs are also full time investors with the opportunity to make substantial profits from their investments. VCs tend to have a fully staffed office while angels tend to work alone. Angels invest in seed and startup (pre-revenue ventures) and early stage companies while VCs tend to invest in later stage, growth companies. VCs generally pick a few business segments in which the general partners have substantial experience and make all their investments in these verticals.
“Investing in companies that will scale” means funding a venture that will grow very rapidly in the first five to seven years, providing an opportunity for the investors to exit with a high-multiple return on investment. For example, a pre-revenue company valued at $1 million at the time of an investment that grows to a highly-profitable company with $25 million in revenues that could be valued at $30 million in five years is a highly scalable investment. This example would result in a 30X ROI (100% per year) for the investors for this company. If, on the other hand, the same company were only able to achieve a valuation of $3 million in five years at exit, the ROI to investors would be only 3X (or 25% per year) for this investment.
Angel investing is a risky opportunity. Of ten angel investments, the investor will lose all invested capital in about one-half and receive a fraction of capital returned or a small return on investment in most of the rest. Angels enjoy a highly successful exit in only about one in ten investments.
As a highly risky investment asset class, angel investors expect a 25% per year return on investment (compared to perhaps 10% per year for investing in in public markets). If an angel investor has $1 million invested in a diversified portfolio of ten companies (assume $100,000 per company), his portfolio should be worth $3 million in five years. $1 million compounded at 25% per year will triple in five years ($1 million x 1.25 x 1.25 x 1.25 x 1.25 x 1.25 = $3.05 million, close enough).
If an angel investor’s portfolio is to triple in value in five years, earning 25% per year ROI, and nine of ten companies fail, that single successful investment must be a “home run” to bring the value of the portfolio up to triple the value five years earlier. Since, in this scenario, we invested $100,000 in each company and the portfolio must be worth $3 million after five years and only one company must provide all the ROI, that single successful exit must be worth $3 million, or a 30X ROI for that investment (to achieve 25% for the portfolio).
Since we angels have no idea at the outset which of our investments will be produce that high return (or we would not invest in the other nine), each and every one of our investment must have the potential at the time we invest of achieving a huge ROI, 30X in this example. For this reason, a sound angel portfolio should not contain investments with the potential to only produce smaller returns on investment and should be limited to companies that will scale.