Angel Investing
Building your track record (and making money)
A lot of VC’s make angel investments. This used to be perceived as a big conflict, but somehow, there seems to be much less concern about this these days. In particular, I notice that more and more young VC’s are finding themselves on the cap table of startups. I actually think that this is a pretty positive development in the market, as more people are able to vote with their dollars, start to build a track record, and hopefully personally enrich themselves. This will be a bit more a general post on angel investing, but I’ll close a bit at the end with some specific thoughts of how to do it in the context of being an employee of a venture fund.
How Much?
One question that comes up often is how much one should be investing in startups. This is actually two questions, the first being how much one should be investing in the category as a part of their net worth, and the second is how much they should be investing into any one startup. These two factors are sometimes in opposition of one another.
I can’t give specific investment advice to anyone, but my POV is that if you are a professional VC, you should do better as an angel than 90%+ of angels (there are a lot of wealthy individuals and doctors and dentists out there who like to dabble). You should have superior deal flow and a superior data set that you can use to evaluate companies. One thing I’ve realized in venture is that while any one company is highly risky, a portfolio of startups is actually not that risky. So my POV is that if someone is in a position to perform better than 90% of the market, you should feel comfortable putting a meaningful % of your net worth into the category. And if you layer in the other benefits of participating in the market in this way, I’d encourage young VC’s to live lean in their early years and be willing to deploy meaningful dollars.
In terms of how much to invest in any one company, this is a trade-off. There is sort of an optimal check-size that maximizes your access to companies. Below a certain amount, you are too small for a founder to worry about. Above a certain size, you become tough to squeeze into a cap table. As a VC doing angel investments, you can probably skew a little lower because you don’t need to rely on our angel check size to drive deal flow. My recommendation is to have a standard check size that you are comfortable with based on the size of your portfolio (more on that below) and be willing to scale that down in order to get access. At this point in your life, you should not say “no” to a great opportunity because you can’t get enough allocation. Getting any piece of a hot company is better than not getting a piece, so you don’t want to be too dogmatic about your check size early on.
How Many?
Most angels I know don’t go into this thinking that this is part of a broader strategy. They see the opportunity to do one deal, figure out a check size, and then commit. Then another opportunity arises and you do another one. Next thing you know, you have a portfolio.
Most people I know don’t expect to make that many angel investments, and so they are haphazard about how they approach their portfolio. But I think it’s very helpful to build a big enough portfolio. This serves the two interests that a VC might have in angel investing - making money and building a track record. The more investments you make, the more likely it is that you’ll catch something really exciting. And making enough investments helps manage some of the risk inherent in angel investing. Practically speaking, there are some diminishing returns to portfolio diversification, but I think most folks reading this are unlikely to run into this limit anytime soon. I do think that you’d want to make sure you get some benefits of time diversification, so plan on investing over several years to manage the risk of a large number of companies hitting a market headwind at the same time.
How to Do It?
So, how does one go about making angel investments while employed by a VC firm?
Most VC firms have policies stating that team members (and partners) are restricted from making angel investments. The most common situation is that angel investments are only allowed in a) companies that are out of scope for the firm and b) companies that are in scope but that the firm decided not to invest in. But sometimes, angel investments are just not allowed across the board. Among other reasons, a firm doesn’t want to be in a position where they want to invest in a company, but an entrepreneur is uncomfortable about it because someone on the team is invested in a competitor. The cost of a potential conflict like this is too significant (even if the likelihood that it becomes an issue is low).
The most above-board way to do this is to get clarity early on from your partners on what their angel investment policy is. Then once you have clarity, be totally transparent about what you are planning to do. It will feel friction-full and probably will limit the number of angel investments that you are likely to make. The easiest way to have this conversation is actually to have already made some angel investments before you joined, and so you can say “hey, I’ve made some angel investments in the past and get approached occasionally. How should I approach it here? Obviously, I would only pursue things that isn’t a fit for the firm or that the firm has passed on.”
The medium-board way to do it is to figure out what the policies are more informally. This could be done by talking to other associates, venture partners, or just trying to read any written documentation on the topic. You can do some sleuthing on LI or Angelist to figure out who at the firm has done angel investments during their tenure, and then just ask about how that went down. Then, try to follow the spirit of the guidelines, but not necessarily run it up the flagpole every single time you want to make an investment. The risk is that one of your partners learns that you made an angel investment after the fact and gets pissed. You want to only make investments that you can explain as having not been in conflict of the firm and possibly beneficial to proving the firm access down the road. My guess is that most angel investment from VC’s happen in this sort of informal way.
The below-board way to do this is just to make angel investments, not tell anyone, and to ignore any restrictions that your firm has placed on these activities. Some folks go out of their way to obfuscate investments like this by creating a separate entity or investing on behalf of a family member. Some folks might even pool capital together with others and invest together as a syndicate without revealing this activity to their firms. While I admire the creativity of this approach, I’d recommend doing this at your own risk. I personally think that most people should be free to invest as they’d like, but I do also think that the interests of your employers should be respected and ought to come first.
Hopefully this is a helpful overview. My belief is that there is nothing better for one’s development as an early stage investor as writing actual checks. It changes your mentality from “getting deals done” to actually trying to generate a return. It also helps augment one’s track record and provides more currency for a junior investor to be able to leverage with other VCs or operators that might be interested in meeting these companies. It’s also a way to potentially get a great return on your dollars at a time in one’s life when one has a very long time horizon and high risk tolerance, which is perfect for the angel investing asset class.
