Reflections from My Early Angel Investing Journey
Some retrospective lessons after investing in 40+ startups.
Since starting my angel investing journey in January 2021, I have invested in 40+ startups directly or via syndicates / SPV on platforms such as AngelList, and Gaingels.
After my experience in both extreme ends of bull and bear markets, I want to share tons of learnings with any angel investors starting their journey or thinking about it:
Don't invest more than what you can afford to lose.
AngelList as your private Dojo.
Develop your investment strategy.
Recognize different players have different goals than yours.
Join angel groups to increase your learnings, network, and deal flow.
How Did We End Up Here?
To fully appreciate the learnings, let's zoom out and talk about the market since I started.
Bull Market
Founders benefitted from the abundance of capital thanks to market-friendly monetary policies plus accessibility that brought in many new investors and fund managers to the ecosystem. Growth was the primary narrative in a market that induced plenty of FOMO in an asset class that was supposed to be about long-term investing.
In this market, there were tons of deals where startup founders successfully raised rounds at high valuations and shortened the time between rounds.
This phenomenon creates startup valuation mark-ups, artificially boosting key return metrics such as IRR. With those return metrics, fund managers can attract more investors' money to invest in private companies to chase growth, allowing fund managers to raise more funds with larger AUMs ready to invest, which you can see in the flywheel above.
Bear Market
Venture capital (and other markets) was affected by the massive public tech stocks sell-off, inflationary concerns, interest rate hikes, and overall macroeconomic concerns over a possible global recession that no one wants to admit. The new risk-off narrative has created a more challenging fundraising environment for founders. Fundamentals and due diligence revert to the standard time before the "pandemic-boosted VC boom" as investors are taking longer with the process and negotiating harder on terms. We see more "down round" deals with lower valuations from the frothy times.
Don't Invest More than What You Can Afford to Lose.
While it's obvious that everyone knows investing in startups is risky, it's a good reminder not to invest more than what you can afford to lose.
As many investors, including myself, got caught in last year's bull market euphoria, we overextended ourselves in investing.
Investing in private companies is significantly different than buying public stocks, as shown in the chart below.
Before you allocate specific funds to invest in startups, it's prudent to think about your own investment goals, time horizons, and liquidity needs.
Given the investment goal for this asset class is growth, you should be willing to take on risky investments and potentially lose money in exchange for a massive return as a reward.
Time Horizon
You can invest and hold stocks long-term or make short-term speculative trades for the public market. In addition, you should be comfortable with the risk of experiencing both bear and bull markets, given how long the investment cycle is. Investing in private companies might take 6-7 years before any liquidity event (depending on stages).
If you are considering buying a house, paying for a kid's school tuition, wedding, and other typical expenditures, you should not rely on the funds from private investments to pay for those costs.
For anyone with excess liquidity in the retirement / IRA account, it's advisable to set up an account with retirement investing platforms such as Alto IRA (of which I am a customer). Given the long-term nature of an IRA account, it makes sense to use retirement money to invest in alternative assets with a long-term horizon.
Liquidity
Unlike public stocks, where you can sell in the open exchanges through your broker anytime you want, you can only get your private investment money back from liquidity events.
Since layoffs are becoming more common, your investment portfolio allocation should exclude the funds set aside if you lose income/job.
There is always the possibility that the startup might get sold early on. More often than not, you might get the acquirer's shares from the M&A transaction.
If you are lucky enough to invest in companies that have grown to late-stage/Pre-IPO from early-stage, you might be able to sell your shares on secondary markets such as EquityZen. Selling in the secondary market is subject to unpredictable market conditions, which might not be favorable, as we have witnessed in 2022.
In addition, if you invest in startups with funds or syndicates, managers have total control over the distribution structure in the event of liquidity exit.
Risk Management
A benefit of investing in the public stock market is hedging your exposure against any significant price movement with various financial instruments such as options or market strategies.
In private investment, portfolio diversification is one of the limited risk management moves you can make. Capping the percentage of risky assets (as explained below) is another move.
Information
Public companies must file quarterly earnings reports and regular filings for any material disclosure, such as insider management selling.
Unless you have information rights as an investor (usually granted to lead VC), you are generally blind to what's going on with private company investment. Private companies are not obligated to disclose any information, even if it is significant like this one about DataRobot.
One of the reasons why I enjoy investing directly in startups is the opportunity to establish direct relationships with founders. The promising ones usually provide insightful monthly/quarterly updates to all the investors on the cap table.
Limit Angel Investment %
Given this asset class's riskiness, limiting the percentage of angel investment in the overall investable assets is prudent.
"Even sophisticated institutions that have the financial wherewithal to take significant risk and have access to the premier venture funds tend to allocate no more than 5 percent to 10 percent of their portfolios to venture capital. You don't have the staying power or the financial expertise of these endowments, so try to limit the size of your overall bet." - Andy Rachleff, the co-founder of Wealthfront & Benchmark Capital.
While Andy suggested limiting the size of angel investing to 10% of your investable assets, you should set that % based on your risk tolerance and investment goals.
You can read more about his thoughts on angel investing here.
Easy to Play, Hard to Master
Angel investing is accessible to anyone thanks to the rise of platforms such as AngelList and Republic. AngelList is a great platform to sign up quickly, join syndicates, and immediately get deal flow flooding your inbox.
The biggest mistake for many new investors is to rush in and start to invest. AngelList's user experience is so smooth that you can go from looking at memos & pitch decks to signing closing documents and wiring money with a few clicks.
Since all the deals look good early on, you might think angel investing is easy. Much like Texas Hold 'em, investing is an easy game to play but hard to master.
AngelList as Your Private Dojo
My biggest tip is to use AngelList like your own Private Dojo. Instead of rushing to invest, take your time to study each deal's memo and pitch decks to build your deal evaluation process.
Here are the steps to build my process with AngelList deals.
Define My Focus
I use the philosophy Buy What You Know to invest in areas I understand well, which I discussed in an earlier post. This approach provides guardrails to keep me disciplined in sectors I know, which include e-commerce, fintech, SaaS, deep tech, and AI/ML.
Since I'm already an active public stock investor, I primarily focus on early-stage startups since there are more learnings and growth opportunities.
Track Deals in a Google Sheet
For any deals within my focus that come into my inbox, I track them in a simple spreadsheet. The sheet includes deal terms, key metrics, and notes on why I pass or invest in the deal. It allows me to build a simple feedback loop on my decision-making. If my conviction is not nearly enough for certain startups, I will mark them on my watchlist.
Build My Knowledge Base
In terms of learning how to evaluate deals, there are plenty of resources on the internet. Y Combinator Startup Investor School on YouTube has benefited me early on. There are plenty of super angels and investors that I learned from on Twitter and blog posts.
Programs such as Hustle Fund's Angel Squad (which I am a part of) and On Deck Angels can help you level up and connect with other angel investors.
For anyone used to investing in public stocks/ETFs, startup investing is a different game since it's about finding the biggest winners as dictated by Power Law Return. To find the potential break-out companies, Mark Suster gave some valuable tips on developing pattern recognition.
Develop Your Investment Strategy
Since syndicates provide plenty of deal flow, opportunity cost is a significant consideration in the decision-making of an angel investor. The fear of missing out on investments deals with higher upsides potential over risk.
With limited capital for investing in startups, I developed the following framework as I gained more experience.
Here is a synopsis of this framework.
Founder/Market Fit
Many investors find pre-seed deals the hardest to judge, given the limited information available. Strong founder/market fit is table stakes for early pre-seed/seed deals.
Strong signals can come from founders/background & expertise. Fellow Hustle Fund Angel Squad member Jaireh Tecarro asked:
"What hard-earned secrets do the founders possess? Is it through domain expertise or lived experience?"
Given my former founder and product management background, I like founders with solid execution and "0 to 1" product-building experience. Here is an insight shared by Dan Ellis, a fellow Hustle Fund Angel Squad member.
"There are many reasons why startups fail…it could be the wrong time, wrong place. As long as it's not from a failure of execution, I will continue to back founders who have done it before."
If you ask the investors at Hustle Fund, they prefer teams with strong GTM/distribution skillsets. Many of the fund's "first checks" go to startups that are more B2B, sales-oriented with some early traction.
Network, warm intros, and referrals from other founders, operators, and investors provide essential data for any founder-oriented investors.
Market
Market size plays a crucial role in the investor's decision-making process. Given the riskiness of startup investing, the market must be big enough to realize the potential upsides as highlighted below:
To foresee the startup's future growth trajectory when things go right, an investor must have a strong understanding of the market. Given the long tenor before the outcome, you must also figure out which startups are building a venture-backable business vs. small businesses.
Traci Ho Kim (Hustle Fund Angel Squad member) once mentioned another scenario where the investment may languish if the startup growth is similar to small business, given the nature of the market. It's a good reminder to have a solid judgment to minimize the opportunity cost of angel investing.
Timing
As we enter a market facing plenty of macroeconomics uncertainty, the "why now" question becomes more crucial. Here are some examples.
With a possible global recession, many B2B startups might have issues selling to other startups or small businesses. As layoffs and cost-cutting become more regular, there is a lot of uncertainty with investing in these startups.
Public companies such as Netflix, Shopify, and Peloton benefitted from the pandemic boost that affected how we consumed during that period. As the trend of this false tailwind reverses, many companies have to unwind their investment and cut high costs, such as making massive layoffs. Using this proxy also affected how investors view startups affected by this trend reversal.
Tractions
As I gained more experience, my investment strategy expanded to include traction-based investing. Compared to the past, when limited market focus provided guardrails, traction-based investing is more sector-agnostic. Startups that have hit enough milestones to be in the seed prime and Series A rounds fall into this bucket.
Unlike pre-seed/seed startups, these companies have enough traction to provide investors a clue on how close they are to product-market fit or already there. These tractions can include ARR trajectory, growth trends in key operating and financial metrics, margins, strong retention/low churn, and others.
In addition, I like to look at the intangible data, such as whether the founding team addressed any skillsets gaps, such as critical hires with growth or sales background or strong investor signals.
Adding other financial data such as ARR multiples and funding dilution events provides enough signal to find a suitable investment with good upside potential and a derisk profile.
In some cases where startups were marked on my watchlist, as mentioned above, the pre-seed/seed deals evolved into traction-based investments.
Recognize Different Players Have Different Goals Than Yours
For any new angel investor, network and deal flow are the most significant constraints to getting started in angel investing besides capital.
Syndicate leads provide a valuable service on AngelList, which is deal access. Any angel investor can invest as low as $1,000 on each deal and be able to build a massive portfolio diversification with limited capital.
Given how carried interest works, syndicate leads profit from the volume of syndicated deals. Angel investors make money from picking winners through sound judgments.
Since deal volume is the game in syndicates, angel investors see plenty of deals daily, making it hard to separate signals from noise.
On the funny side, many deal memos presented have a more marketing friendly-tone with plenty of 🚀emojis. A new investor might find many deals that seem awesome. There are many instances that I think there are plenty of promising startups ready to transform our world into a tech utopia after reading those memos.
Information Asymmetry
Having access to founders is vital for all my direct investments. Being able to speak directly to founders is crucial in my decision-making process.
For any deals on AngelList, there is a possible information asymmetry where the syndicated lead has:
Direct access to the founder.
Potential access to diligence materials.
Access to other investors to do reference calls.
Strong syndicate leads have provided closer access to founders by organizing Q&A calls and sharing regular updates with angel investors.
Due Diligence on Syndicated Deals
Despite its limitation, I appreciate the role of syndicate leads since they provide much broader deal access beyond my limited network to help me find potential winners.
Instead of just reading on the deal memos and decks provided for the deals that I'm interested in, I learned to put in additional due diligence works to address the information asymmetry gap issue highlighted above.
The following due diligence work could include:
Checking on founders' backgrounds & stories online
Researching the problems/solutions online
Checking references with my network if possible
Talking to domain experts about the market opportunity and risk
Researching on Pitchbook, Crunchbase, and other sites on prior fundraising
Modeling out the deal based on prior dilutions, deal terms, and significant metrics
Invest based on famous founders and investors' reputations
One of my biggest mistakes in early angel investing was investing in startups simply because the founders are well-known. Despite not having the strongest conviction in the market they chose to build their next startup, I invested purely based on reputation.
Another common mistake was to invest in deals based on which famous VC firms are leading. Only a handful of VCs (ex: Union Square Ventures) has consistently outperformed the market. With much bigger bankrolls, VC firms consider each deal a diversified portfolio of other bets.
Other reasons why VC firms invest could be strategic, including business development opportunities, ecosystem growth plays, or early information rights for future deals. Certain VCs have even branched out into other areas, such as media.
Other deals led by corporate venture arms such as Coinbase Ventures and Google Ventures are other examples of why you shouldn't invest solely based on the firm's reputation. Some deals aligned perfectly with the corporate venture's strategy but might not align with your angel investing interests.
Join Angel Groups to Increase Your Learnings, Network, and Deal Flow
Joining programs such as Hustle Fund's Angel Squad and On Deck Angels can help to connect with other angel investors to learn from each other and discuss deals.
Traci Ho Kim said that her most immense support was joining our Sloth DAO Discord group, where she could find like-minded people to discuss and debate on investments. Since our group comprises a diverse group of operators and experts in many fields, including crypto, AI/ML, doctors, engineers, etc., we can create more multi-disciplinary discussions and better mental models.
I have collaborated with my fellow angel investors on many founders' meetings. Deal referrals, warm intros, and networking are some of the benefits of being in an angel tribe. Mentoring Hustle Fund's portfolio companies through their Redwood School has also provided me with some valuable ground-level insights.
Feel free to contact me if you are an angel investor/operator interested in joining our group.
Next Step
If you are interested in me going deeper into some of the topics above or providing more reflections, don't hesitate to contact me on Twitter.
Thanks to Jaireh Tecarro, Traci Ho Kim, Jen Liao, EJ Lawless, Sravi Chennupati, and Dan Ellis for reading drafts of this and/or providing valuable insights (nuggets) for this post.
PS: Sign up☟ if you find this interesting. Email me if you have any excellent topics for me to explore more!