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How to get started with angel investing – and what you should be looking for in a startup
Angel investing offers the possibility of great returns in exchange for taking on substantial risk.
For those comfortable with the trade-off and willing to plunge into the world of startups, there are a number of key lessons more experienced angels can offer.
From knowing where to begin, how much you'll need to invest, and how to spot a potential success story, there are plenty of pitfalls to avoid.
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Not everyone can establish a successful startup, but, with a little skill and a lot of luck, you could invest in one.
You find a start-up destined for great things, see its enormous potential when no one else did, and get on board for that ride to the moon. It's the dream, isn't it? At least for those whose colour blindness precluded them from becoming a fighter pilot.
Well, it's not really that simple, according to Kate Cornick, the CEO of LaunchVic, the Victorian government's startup program.
"Startup investing is really unique. For one to work and to be successful it needs a founder with a vision, an opportunity and the ability to grow it into a big company – and that's a big ask," Cornick told Business Insider Australia.
"So the risks are inherently quite high. But at the same time, the reward when it pays off is fabulous. There are plenty of examples of people coming incredibly wealthy from investing in these kinds of startups."
In other words, the road to success is paved with failures. For every Atlassian, there's a Theranos. For every Canva, a WeWork. A Juicero. A YikYak, a Jawbone – the list goes on of companies which were thought to be full of potential but ultimately flopped.
But, while being an angel investor is no easy road, it is possible. So how does one get started in angel investing?
Get yourself up to speed with the world of startups
Startups are, by definition, early-stage companies which may or may not have customers yet. The first mistake Cornick sees would-be investors make is that they don't quite grasp this simple fact.
"They come in expecting to see a company that's already got revenue coming in and got market share and they expect to take a great big slice of equity for their trouble. That's not how it works," Cornick said. "The reality is you're going to be taking a small slice of a high-risk company that really doesn't have a great deal to show for it except for maybe a great vision and a great team."
While such expectations aren't uncommon, there's a pretty simple way to get your feet reacquainted with the ground. Cornick recommends immersion therapy.
"Start going to pitch nights and get a feel for the startup world. Once you start to get to know them, you might find there's a class you find yourself gravitating towards, be it fintech (financial technology), adtech, social impact companies or something else entirely."
Pitch nights – where startup founders try to sell their idea to a crowd of potential investors – is the perfect environment in which to dip your toes, Cornick insists. Another is surrounding yourself with mentors.
"The most important thing you can do if you're new, from my point of view, is to join an angel network quickly. Angel networks are syndicates of angels coming together, and the beauty of that is that you get to learn from people that are more experienced and you also get to leverage their firepower."
While a large pool of capital doesn't hurt, neither does expertise.
"They also bring knowledge and connections and mentorship to the founder. What might be more useful for the venture than money could be simply for a startup to get their first customer. So if you've got 20 angels around a table, you've extended their network and you've boosted your chance of success."
Cornick has also seen the flip side, where an investor gets too involved, and does more harm than good.
"Understand you are backing a team and a vision and you can't slow that vision down by doing things like asking for too much due diligence and asking too much upfront from that company for example."
"It is knowing when to press the pedal and accelerate and drive and also when to step back and let the founder do their thing."
But just as angels should seek out the right startup, so too should they strive to be the right investor.
"Sometimes we can be our own worst enemies in investing and can ourselves risk the success of the venture.
Having the right angel investing strategy
Given the risks, the right strategy is one that appreciates the need for diversification.
Duco van Breemen sees plenty of startups himself. The manager of Haymarket HQ – a Sydney-based startup hub focused on launching startups into Asia – says that risk should inform your investment strategy.
“Angel investing is more about hitting a home-run than about averaging. If you’re looking to decrease risk and increase returns, you’re better off taking an 'index approach' to angel investing by investing in a minimum of 40 startups versus betting heavy on a few," he told Business Insider Australia.
The logic goes that if one startup in 100 goes on to blow the lights out – in truth, the statistical likelihood is probably even lower – then you really shouldn't bet the house on just one or two. If you're going to back 40 or more quality ventures though, you'll also need to reject quite a few more.
"Therefore, my number one tip would be to increase your access to deal flow by networking with other angel investors to co-invest in good deals all the while becoming proficient in saying no to most other deals," van Breemen said.
Invest then knowing that many of the cheques you write won't ever come back to you.
"Make sure you only invest what you can afford to lose. It's high risk and you've got to know the rules of the game," Cornick said.
How much do you need to start angel investing?
Unlike buying shares, the amount of investment you'll need to stump up is a little higher. But while career investors might be putting up six-figure amounts, it's by no means the rule.
Cornick shares the story of Matt Allen, the general partner of Melbourne-based investment fund Pick and Shovel.
"Matt's very prolific and he made his first investment with a cheque for $10,000. It's not an extraordinary amount but it is done," Cornick said.
"If you're a smaller investor and have anywhere up to $100,000, I'd really suggest you go through an angel network, syndicate and then you can put in $5,000 to $10,000 per company and diversify."
What to look for in a startup
While angels may have different approaches, the foundations of a good start-up and a good business have the same tenants.
Sydney-based angel Rayn Ong says, in his view, there are a few basic things he likes to see: a team, a product, a market, and a plan.
"Always look for high-quality teams with complementary skills," Ong said. "Statistically speaking, founding teams of two are better than one, while four is too much. I like a builder and seller combination with good communication between them."
Between them, they should have an idea for which enough people will want to pay.
"A good product solves a really painful problem. If the problem is not painful enough, no one will pay for it," Ong said, noting that the best products solve that "a really painful problem for many people."
Lastly, they should have a plan to execute.
"The main purpose of the plan is to evaluate if the team can build the proposed product and get it into the hand of their customers before they run out of money. Can they show enough progress to raise the next round of funding from later stage investors?" he said.
If it ticks these boxes, then you're on the right path. If not, back to the drawing board you go.
Disclaimer: This article contains general information only and is not intended to be used as personal advice.
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