Its 3AM in the morning and like all considerate new borns, my son wants to play. After a few games of peek-a-boo and lots of rocking, I eventually get him to sleep in my arms. That’s when the itch starts…on my back. Do I put him down and risk waking him up?
The creative side of me (that comes out just before the sun rises) likens this to angel investing. I’m sure you have come across startups that fall outside of what you’d typically invest in. The founder is very passionate and persuasive and you’re ready to write the cheque but do you scratch that itch? There are always subjective factors at play but for the most part the answer is no. Professional investing requires discipline. Returns of 25%+ p.a. are possible if you are diligent in applying investment principles.
The starting point is developing an investment mandate. This will be your guide to what you should and shouldn’t invest in to. An investment mandate is typically made up of the following parts.
This is shaped by your experience and network. Those that have been in banking know the market, are comfortable with terminology as well as transactions in this space. Startups can’t BS you. Investing in what you know comes naturally and is good practice.
The other point relating to this is your professional network. Once you’ve invested in a company you’ll hopefully be able to open doors for the startup. Your contribution to the business is more than capital, it extends to your effect on its bottom line. The greater the synergies, the more valuable you are to a startup, the more money you’ll ultimately make.
These same principles are true for a company’s geographic focus. Angels based in Jo’burg will find it easier to help startups focused on this market over startups that are focused on the Kenyan market for example.
Another major consideration is when to invest in the startup. Some investors prefer to invest at idea stage when in the cost of capital is at its lowest and upside is highest. Others prefer to de-risk their investment by waiting for the startup to progress through a few stages. The skill set required and involvement at various stages of a startup differ. Angels tend to be more hands on at the idea phase of a startup, assisting in the product development, while those that invest later are more focused on business development. The stages can be summarised as:
Idea -> Product Development -> Prototype Ready -> Product Ready -> Post Revenue
Choosing your investment range or ticket size is something that relates to your overall investment portfolio. Ultimately you want to diversify. This means you should have a reasonable number of startups in your portfolio. Ten investments over fives years (or there about) is a good initial target. Over time you want to increase this to twenty or more. If you have R5m in capital to invest your average deal size needs to be R500k to have a portfolio of ten startups. Determine a minimum and maximum around this average deal size to give yourself an investment range.
Experience investors will tell you they work best with teams that have specific personalities or technical expertise. Do you share the same values? Do you share the same passion? Do you complement each other’s skill set? Angel investing is a very personal experience, much like getting married. Getting in bed with the wrong partners can get messy. Know what you're looking for in a founding team.
Investing closer to home is always good practice, particularly in the early days of a company. You are part of the team as an angel investor and working remotely always adds another layer of complexity. Angel investors often have to put out fires or mediate differences between other founding members. It’s easier to do this over a coffee than Skype.
A consideration for some investors is whether or not to syndicate. This involves investing along side other angels. The benefits of syndication will be discussed in a separate blog but they are expensive.
Angels often develop tag team partners over time, partners that they bring along to any deal. Questions around the level of syndication (number of partners and split percentage) as well as the roles (lead investor vs supporting role) are just as important as electing to syndicate. Angels that are newer to this space may do more syndication in their early days and play a supporting role to more experienced angels. Gaining experience much like a mentee would from a mentor.
Listed above are genetic factors that form part of most, if not all, investment mandates. Angels should also have their own personal preferences built in to their investment process. For example, this could include a preference for B2B businesses over B2C. Others may prefer a business model that is built on annuity income like a subscription service over one that is transactional.
A venture capital fund has a strict investment mandate, the same is not necessary when investing your own money but it is good practice. The mandate doesn’t need to be a physical document. It can be something you’re consciously aware of when making decisions but it should be revisited from time to time. It is a good reference for when you get that next itch.