Change in angel investment strategy

Over the past few years, my angel investing strategy has been to be very selectively aggressive. I would invest relatively large amounts of capital in very few companies and typically sit on the board as well. I believed that my ability to identify unique companies and help them out would lead to outsized returns. Over the past few months, I have fundamentally revised this strategy.

I have had the pleasure of interacting with a large number of angels with numerous investment strategies. Without fail, the companies that succeeded for them were never those they might have expected to succeed the most at the time of investment. Their success as investors most often came down to luck and did not seem correlated with the intensity of the due diligence they had conducted or a priori quality of the management teams they had backed.

Given the hit driven nature of the angel investing business, it’s important for angels to have at least one hit in their portfolio to cover the losses from the duds. Angels who, on average, had invested in less than eight companies lost money on their investments, while those who invested in more than eight companies on average made money on their investment.

By May 2008, I had invested in 6 companies and sat on the board of 4 of them. Since then, given how busy I am with OLX, I have scaled back my existing board involvement dramatically, divided my average investment size by a factor of five and I am now invested in 15 companies. I have not joined the board of any of the new portfolio companies and don’t intend to for future investments either.

I invest mostly in early stage startups at the seed level as I think it’s the least efficient and most fragmented stage of the investing process. Series A rounds and beyond are well covered by venture capital and private equity firms and are much more competitive. I focus on direct to consumer businesses both because I understand the space better and the due diligence is significantly easier to do (why active entrepreneurs mostly invest in consumer internet companies). I also often invest in companies off the beaten path (outside of Silicon Valley and often outside of the US) reflecting a small comparative advantage in international sourcing because of my background.

In the past few months, I added another constraint. Given the likely dearth of venture capital investments in 2009 (why VCs invest less in downturns), I am currently only investing in companies with very low capital requirements that are likely to reach profitability on the seed funding. I also insist on very low valuations (often much lower than $1 million pre-money) to compensate for the likely increase in default rate caused by the lack of funding and potential acquirers.

  1. November 24th, 2008 | 1:42 pm

    What is your average investment / company or project?

  2. November 24th, 2008 | 1:43 pm

    It used to be $250k, now it’s $50k. I suppose it also reflects the significant drop in my net worth this year.

  3. November 24th, 2008 | 1:46 pm

    And how do you decide where should you invest, at what project? How many of your investments are profitable?
    Since you invest in early stages, I assume -just like any new business- a big percentage of these companies fail… Wrong?

  4. November 24th, 2008 | 1:49 pm

    And one more thing Fabrice. One of the adepts of free model (ad and AdSense supported model), Markus from POF is thinking of introducing paid services as well. What are your plans with OLX? Your model is similar and I am just wondering…

  5. November 24th, 2008 | 1:52 pm

    It’s hard to tell how my investments are doing. They are early stage so the exits are years away.

    I was very lucky with my last batch of investments. In 1999/2000, I invested in 7 companies. 1 went public, 5 sold successfully, 1 went under. However, it took forever. The exits were all between 2005 and 2007. In 2001/2002 it looked like they might all fail!

  6. November 24th, 2008 | 1:54 pm

    Regarding OLX: we will not charge for listings, but we will charge for “Featured Listings” the way Gumtree or Loquo do it.

  7. mike
    November 24th, 2008 | 11:52 pm

    50K at much lower than 1 mm pre-money, maybe ~500K, thats roughly 10% in a startup that can be profitable to break even with 50K and with minimal involvement from your part!! Wow, Fabrice, those are pretty strict requirements. I think if an entrepreneur can make a company profitable with that low of an investment, bootstrapping and credit card debt would be the way to go. I mean Y Combinator does take 6% for 10-12K but I think there goal is to get you to prototype which can be leagues away from profitability.

  8. November 25th, 2008 | 2:20 am

    Mike: You forget my investment is not the only investment. Let’s say we raise $300k on $700k pre -> $1 million post -> $50k = 5%…

  9. mike
    November 25th, 2008 | 3:46 am

    yes true, most likely the deal would be done in syndication but giving up 30% of your company before a series A is tough, but then again, times have changed as you have correctly pointed out !!

  10. November 28th, 2008 | 6:38 pm

    50K is surprisingly quite low given that Angels often think small investments are not worth it (small profit outlook) as per I was told.
    Now your logic is that you make many small investments which amount to one or two large ones while spreading the risk.
    Still, I have heard that some angels may alternatively consider lending money first when the sum involved is small.
    Fabrice, would you happen to know angels in the food industry who invest both ways?

  11. November 29th, 2008 | 9:57 am

    Fred: For startups, lending them money makes little sense. You essentially get the same risk as equity with none of the upside.

    I don’t know any VCs in the food industry…

  12. November 29th, 2008 | 9:57 am

    Or angels for that matter…

  13. November 29th, 2008 | 1:18 pm

    I wish I had discussed in person with that angel from Atlanta who mentioned lending money to start-ups as a first step of his investment strategy.
    The only way I see that strategy making a bit more sense is if he lends for a very short term (1 year max) against a high interest rate, say 10%. Then I imagine that the loan is convertible, just like a bond. So at terms, the angel gets his interest payment plus equity against the principal of the loan, along with a larger bunch of equity following a 1st round of actual capital raise.
    There are a few advantages.
    -The most important one is valuation, which is more accurate and realistic after 1 or 2 years in business. No hassle of pre-money valo for start-ups on year zero then which is always just a gamble.
    -Instead of injecting more capital (vs equity) for say 2 years, the angel opts for less risk by lending money for 1 year max. Then, he can either withdraw (or loose all), or convert + reinforce his stack by subscribing to the actual capital raise.

    I’m just sharing what I think could motivate that angel to invest in such a way.

    In my very case, I am putting in 50K and looking for 300K. I was told many times it’s too small an investment to attract investors. That Atlanta angel could have been an option, but he only invests in Atlanta ventures.

  14. karen rands
    January 17th, 2009 | 8:10 pm

    Good post about Angel Investment strategy.Please see Karen Rands’ recent post on one of our blogs http://www.myvirtualangelworld.com regarding the nature of angel investor groups and how entrepreneurs can prepare for them. http://tinyurl.com/9y95wo
    Also she recently interviewed Dr. Scott Shane, author of Fools Gold about the myths of angel investing on her weekly SPEC Talk Radio show (www.blogtalkradio.com/karen-rands), replay available here http://kugarand.podomatic.com/entry/2008-12-14T18_45_59-08_00. You can connect on facebook, myspace, or twitter too… search for karen_rands

    Savvy Investors see angel investing as a great way to create a multiple on their money if they are smart about mitigating their risk. Karen Rands covers this in her blog entry on entrepreneurblogspace.com RE: Peter Rip’s The Coming Venture Capital Boom in response to Peter Rip’s entry about the state of the VC market in this economic time. Timing is great for companies to prepare to pitch angels and they can learn how by attending the free webinar How to Pitch Angel Investors at http://www.findinvesetorcapital.com and Registering for an initial consultation with a capital consultant at the Launch Funding Network http://www.launchfn.com

    Thanks,
    Karen Rands

  15. Diane
    April 3rd, 2009 | 10:41 pm

    There are VC’s who invest in food and beverage. Two specialty tea companies I
    know of received VC money within the last few years. I found some just by Googling.

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