Angel: How To Invest In Technology Startups – Jason Calcanis
Market Meditations | February 2, 2021
Angel investments. Not for the faint hearted. If you can’t handle losing money, investing in the riskiest asset class on the planet, aka startups, angel investing is not for you. You would likely prefer passive investing in index funds.
If you are prepared to invest some of your wealth here, understanding the risk implications (perhaps with a barbell strategy in mind), proceed with caution.
In today’s letter, we summarise the key takeaways from Jason Calcanis’ (@Jason) book titled Angel: How To Invest In Technology Startups. Calacanis is a popular American entrepreneur, angel investor, authority and podcaster.
Sounds cool but what is it?
If you are angel investing you are in the business of financing smaller startups.
Think the sharks on Shark Tank, if you know the popular show. Here are a few of our favourite clips from it.
One of the sharks, Mark Cuban (@mcuban), has recently had his crypto portfolio exposed. Cuban’s altcoin bag includes a long list of DeFi altcoins. For instance, he holds $134,000 of DeFi protocol Aave, which represents the vast majority of his portfolio.
Angel investing is done with the goal of finding the next big thing ? Think of the early days investors in Uber or Apple. Through doing so, you increase your initial capital by significant amounts.
Your typical angel target would hardly be the likes of a big company that is listed on a large exchange. Rather it is likely:
A younger company ?
Less than 3 years in age or thereabouts.
Little or no product / market fit ❎
To draw on the Uber example, at the time, everyone used taxis or here in the UK, black cabs.
Financially desperate ?
These companies largely have big goals but their smaller status means they don’t fit banks’ credit criteria for financing. Hence the term ‘angel’, angel investors are, in essence, supporting a firm when no one else is ready to just yet. Of course, they all come running if it starts to pick up.
Sometimes people don’t invest in the company because they don’t believe in the idea just yet. Other times, they have just not been quick enough to hear about it.
So why pick an early company without product market fit when you can pick a more mature company that is already showing steady cash flows? It comes down to the risk aspect we mentioned at the beginning of the article.
Remember: high risk, high reward. And the converse is true: Low risk, Low reward. For instance, investing in a more mature company, if you are lucky, will get you 50-100x returns. In relative terms, an angel investment is higher risk but could yield 1,000-10,000x returns.
The author, Jason Calacanis, himself was an early investor in Uber. A startup investment such as Uber, reaching an evaluation of more than 1 billion dollars is called a “Unicorn” amongst angel investors.
? Most angel investments will fail. The sad truth. However, to quote Mark Cuban: “you only have to be right once”. One unicorn is enough to sort you out for life. And, if you follow Taleb’s Barbell strategy and only allocate a small proportion of your capital here, you can limit your downside.
Getting Started With Angel Investing
Not all angel investors are the type of millionaires you might see on Shark Tank. You can get started with smaller sums of money ?
It is true that start ups in the angel stage require large investments but Calacanis provides routes for those without those kind of financial means:
Advisor / Broke Angel
Financial aid is not the only way to support a young company. You can offer skills of your own as an advisor and be involved that way. Perhaps you are great at marketing or coding. Find a way to make yourself an advisor. People doing this are usually rewarded with shares of the company and are called “Broke Angels”. In exchange for these shares, you will have to sacrifice large amounts of your time.
Like the advisor but dedicates even more time. Unlike the Broke Angel, the employee will likely be limited to just one startup. It comes down to whether you want to put all your eggs in one basket. Might be a good choice if the basket looks good enough.
3️⃣ Syndicate Member
The option that Calacanis recommends because it allows for diversification and that glorious chance you find a unicorn. You invest your money into a syndicate that is then being invested by the syndicate lead. Think of an active mutual fund but for angel investors. Plus, you get to decide which deals you’re in on. The minimum investment sits around $2k which is more reasonable for the average investor. Of course, you don’t get something for nothing. As with an actively managed fund, the lead takes a proportion of the return for their time and expertise. In the book, Calacanis references his own syndicate angel.co.
How to Spot a Good Investment
When it comes to mature companies, investors tend to focus on the fundamentals underpinning the company. They use models such as Discounted Cash Flows (used to calculate what a business is worth now based on their projected future returns) to attest to the underlying strength of the company. Cash is king, as they like to say.
This couldn’t be further from the truth when it comes to angel investments. If they had a significant and substantial cash flow why would they need your money? They would go to the bank.
Whilst the idea is important when it comes to angel investments, it is only as good as the person driving it. Finally, I hear you say, the point: invest in the founder(s), not the company.
Here are some things to look for:
The vision ?
There is a fine line between ambition and delusion. Not an easy distinction to make but one you must try to make. Who is extremely committed and passionate and who is downright crazy.
Sweat equity ?
The idea of an angel investment is that you provide a boost of equity and the start-up catapults into success. If the start-up is already knee deep in funding, it should raise some eyebrows. What will your extra funding do that the previous funding was not? Ideally you find something that has not already had tonnes of funding and not shown progress.
Skin in the game ?
Helpful if the founder has a large stake in the startup themselves. That way, the risk is shared.
4️⃣ Diversification ?
Never a bad sign to have more than one founder. You don’t want your investment subject to key man risk (occurs when a business or business unit becomes heavily reliant on a key individual). Even if the founder is brilliant, we are not robots. They can have a sick day, week, month etc. Of course, you also want to identify whether the founders have the skills necessary for the startup to grow. Failing that, perhaps they have the network.
5️⃣ The dream ?
Why did the founder start the business? To make bucket loads of money is not usually a good answer. Usually, they have some self experienced problems that they are looking to fix. Take James Dyson, founder of Dyson as an example: in 1978, he began his entrepreneurial journey when he became frustrated with his vacuum cleaner’s diminishing performance.
6️⃣ Product market fit ?
If the founders’ product didn’t work before, they need a compelling reason for why it will work now. Zoom probably didn’t make as much sense when the world was working in offices, of course, when everything moved to working from home, it became the perfect fit.
7️⃣ Time and money wasting ⏰
Are the founders attending fancy events and working in a lavish office? You will want to know how they are funding that. If it is with investors’ money, you may prefer to find a startup that is more committed to spending time and money on the business.
Admittedly, there are a lot of boxes to tick. Which will mean you will have to get comfortable with being able to turn down extremely motivated people.
They will be persuasive of course, as they are hoping for your funding.
It is important to take as much time as you need to consider the investment and to say no if that is the best course of action. Better than your debit card saying no in a few months time when you try to take out some cash
Finding The Next Big Thing
Angel investors often rely on their network to identify opportunities.
Calacanis is sensitive to the fact that not everyone has friends and families who have a one way ticket to unicorn land. And so, he suggests using the network to identify and try to connect with fellow co-investors.
Who in social media, or on the syndicate pages can you see who is also an angel investor? It’s best to try to engage with them and set up a meeting where you exchange notes on what they are investing, why and what is on their radar.
✅ As the saying goes: I scratch your back, you scratch mine. If you are going to be asking angel investors what they are looking at, be prepared to also bring value. You might want to also tell them what you are looking at.
A win-win scenario that creates more opportunities for both of you. You should aim to discuss with co-investors as often as possible. This way, you go from the angel outsider trying to find the next big thing on the syndicate platform to the insider angel, partying in heaven with all the potential unicorns.
And there you have it. If you hadn’t had enough disclaimers, here is another: angel investments are extremely high risk. Proceed with caution. However, they offer potential extremely lucrative returns. Now you know what they are, consider the resources that guide you with regards to getting involved. As you select your angel investments, reference back to the checklist, to ensure the founder and startup conveys the right characteristics. Welcome to the realm of high risk, high reward. It’s nice to have you here (make sure you can stick around though).