What I’ve learned from investing in 100 startups
Since I started angel investing 14 years ago, I’ve invested in over 100 early-stage startups. Here’s what I’ve learned about what works in angel investing and what doesn’t through painful experience and a few successes.
1. It takes 7–12 years for returns
Startups claim they’ll exit in 3–5 years. So I made a bunch of investments over the first 3 years expecting those returns to fund the next investments.
After 3 years, my portfolio of 10 companies had returned exactly $0. The piggy bank was empty. I had nothing yet for my efforts except ten lines on ten cap tables. Oops.
Although I eventually did well from those investments, it took 9 years just to get back to breakeven and 12 years before getting a decent return. (See my earlier article analyzing that portfolio.)
The J-curve is a killer. Losses come quickly. Successes take 7–10 years. Big successes take 10–15 years. If you want to be an angel investor, be prepared to wait.
2. Don’t invest in what I don’t know
I’ve spent 25 years in computer networking. When I see a pitch for a new networking technology claiming a $20 billion opportunity, I know the market for their niche is really only $20 million. I personally know the half dozen people who’ve built similar products that went nowhere.
Though the pitch is convincing, the startup has no chance. I wonder who invests in this, but people always do. People who don’t know the industry. I wished there was a ratings site somewhere where I could warn them, but there isn’t, so those investors are throwing their money away.
My bad failures, the stupid investments I later regretted, were inevitably in industries I didn’t know. The pitches were convincing. I didn’t know enough to realize all the assumptions were wrong.
So if I don’t know enough about the industry to accurately evaluate the opportunity, I pass no matter how great the opportunity sounds.
3. Invest with a group
Since I only have expertise in computer networking and climate tech, the only way not to limit myself to those sectors is to invest with a group.
I may not know anything about cancer drugs, but if I’m in an investment group with oncology doctors, pharma executives, medical researchers and FDA consultants and they say this startup has developed the greatest treatment ever, count me in for an investment.
Pooling our money, time, and expertise helps invest in a larger number of startups across a wider range of industries.
4. Need a big portfolio
About half of startups fail completely. Another 40% return less than investors put in. Only 10% provide a positive return. Most of those are small.
A 2x or 3x return is nice, but can’t make up for all the losses. Almost all returns come from a small number of very big winners. At Tech Coast Angels, 74% of our returns came from 3 of the 179 companies we’ve invested in. To do well, you need to have invested in one of those 3 big winners.
I either need a big portfolio of investments or be an amazingly prescient investor. Since the evidence shows I’m not the latter, I need a lot of investments.
5. Look for exponential businesses
With a 90% failure rate, a 10x return for one of 10 companies is not much better than break even. A 20x return that takes 12 years is an annualized ROI of 6% for the portfolio. I can do better putting my money into an S&P index fund, donate 5% to founders, and still come out ahead.
I need a 100x exit to get a 21% ROI and make up for having the money locked away for years.
That means having a good product and a good business is not enough. The opportunity has to be exponential to be a good investment.
6. Kiss a lot of princes
The need for 100x returns means I have to pass on almost every pitch. If the valuation is too high, the opportunity too small, growth too slow, or exits multiples too low, it’s not a good investment. Which means I need to hear a hundred pitches for every investment I make.
The hardest part of angel investing is having to pass on the 99% of pitches, many of which are great businesses and wonderful founders who need investment. It can be painful to say no.
7. Avoid bad investment terms
I can live with failures. The ones that kill me are the startups that succeed, but don’t generate a return.
Liquidation preferences can mean later investors get 4x their money back before early investors get anything, which usually means we get nothing.
Pay-to-play requirements can wipe out investors who don’t reinvest in later rounds.
A $6m pre-money valuation can turn into a $20m post-money valuation if the founder does multiple rounds of SAFEs and convertible notes before the priced round.
The worst are the companies that do well, but never exit. The founders and managers pay themselves handsomely, but the stock itself is never monetized. My investment sits locked up as a line on the cap table forever. This is worse than a failure where I can at least take the tax write-off.
8. Beware hype
Everyone wants to invest in the new new thing: SaaS. AI. Climate.
What matters is not what’s hot now but what will become invaluable in 5–12 years.
Remember crypto? Everyone was throwing money at any startup that had blockchain in their pitch. Now, those investments are dead.
Yes, there will be big winners in the hottest space (which is why the space is so hot), but unless you got in before anyone had heard of it, that ship has already sailed. What’s being pitched now are the word salad me-too’s jumping onto a crowded bandwagon.
9. Ignore FOMO
The toughest thing to get past is the fear of missing out. If everyone is investing in something, it must be great, right?
Perhaps. But usually not.
If you miss one, don’t worry, there will be another great startup pitching you tomorrow.
The best advice I was ever given when I started angel investing is don’t invest right away. Sit back, watch, listen, learn. 90% will fail. Wait until you find one that not only sounds great (they all do), but that you truly believe in. One that you’re either convinced has absolutely no chance of failing, or is on a mission that you won’t mind if it fails.
10. Do it because you enjoy it
There are easier ways to make money than angel investing, and I’d probably earn a better return, too. But I do it anyway. Not to make money but because I enjoy it. I like working with founders and being part of their journey. I enjoy playing a small part in helping them succeed.
I invest in Amazon and Netflix, too, but does my money make a difference? Can I sit down with the CEO over coffee to discuss strategy? Of course not.
So the most important thing I’ve learned is not to look at angel investing primarily as a way to make money. Do it because you enjoy it. Do it because you want to make a difference.
That means you have to be willing to change your definition of what constitutes success from simple financial returns and break many of the rules I’ve just listed when it serves a higher purpose.
