Build An Angel Portfolio Like the Experts
If angel investing is your passion, you’re in it long term; and getting a good rate of return ensures you can continue investing for years. That’s why developing a strong angel portfolio is so important. Finding the right companies, figuring out how many to invest in and which types of deals to focus on is the magic formula angels are after.
When I was first starting my own portfolio, I sought the counsel of experienced angels. One of the best is John O. Huston, founder and chair emeritus at Ohio TechAngel Funds. Huston joined two other top angels: David S. Rose, founder of the New York Angels and Dan Rosen, chairman of the Alliance of Angels in Seattle, in one of ACA’s best webinars. Although no two angels use exactly the same approach, the discussion offers excellent tips and tricks for building an angel portfolio with the potential to deliver good returns.
How many companies should be in your portfolio?
This is a loaded question. Ideally, an angel would invest in just a few companies and get amazing returns. However, Huston believes this could stunt the learning process. “The worst thing that can happen to a new angel investor in my view is having a home run with the first one or two, and believing they have this thing figured out,” he said.
In the real world, a lot of deals don’t work out and many companies fold. Angel investors will inevitably lose money on some deals. At the on-set, it’s impossible to know which investments will succeed. That’s why experts teach the “Law of Large Numbers.”
This law is demonstrated in a chart developed by Simeon Simeonov, which shows that the probability of return depends upon the number of companies an angel invests in. In general, the more companies in your portfolio, the higher likelihood of a good rate of return. For example, with a five company portfolio, the 50 percent probability mark intersects at 1X, which is where you make your money back. But that probability increases as the number of companies increases. That’s why angels like Rose suggest a portfolio of 30-80 deals.
However, there are different views about the right number. Rosen’s magic portfolio size is 12-30 companies, because in his view, “An individual can’t really do good due diligence on 100 deals.” To help, the Angel Capital Association has a helpful due diligence checklist.
Rose agrees that due diligence is key when zeroing in on the number of companies to invest in. According to a Rob Wiltbank study on the subject, there is a direct correlation between angel investors who do due diligence and those who experience a good rate of return.
For Huston, “It comes down to how many deals can you do a good job with?” Of course, it also depends on how much money you have to invest as an angel.
All things considered, experts agree that angels must be disciplined in investment, or the Law of Large numbers won’t work.
Selecting a potentially good deal vs. looking for home runs
Angels are always looking for good deals that have the potential to provide a great rate of return. But what does it take to be considered a “good” deal? For Rose it’s simple. If it isn’t clear how a company can return 2, 3, 4 or more times your investment, keep looking. But don’t stop there; it’s also good to reach for the stars. “Target TGT +1.37% a 30X return,” he said.
Of course, 30X return deals are hard to find, but that doesn’t mean you shouldn’t hunt for them. Underscoring the near impossibility of knowing which deals will actually turn out, all three angels mentioned deals they thought would deliver great returns but didn’t work out. As more than half of angel investments will lose money, it is important to have some investments in your portfolio that have the potential for making up for the losses.
Determining how much to set aside for follow-on investments
Experts agree that follow-on investments should be a considered part of every angel’s portfolio strategy. The one-and-done idea often does not work to an angel’s advantage. Sometimes the company is doing well and has an “up round” where another investment better ensures your stock ownership position at exit. If a company needs follow-on money later, doesn’t get it and then goes under, you have a loss and your portfolio suffers.
Experts like Rosen suggest dividing (by two or three) what you set aside for a company. For example, if you plan to invest a total of $10,000 in a deal, invest $5,000 initially and hold the other $5,000 for follow-on. “I like follow-on rounds when you have great visibility into a company’s performance,” he added.
Diversifying a portfolio by industries, geography, and business stage
Many new angels ask what angel diversification really means. Is it about the number of deals you do or are there other important nuances like ensuring your portfolio includes a variety of sectors, geographic regions and stages of business? From my experience, total number of deals is the most important.
Among the others, vintage years should be considered, because the longer companies are around, typically the better the impact on returns, Rosen explained. In terms of industry, Rose says it’s not ideal to invest in industries you don’t know much about because due diligence is harder and it is also more difficult to add value to the company after you invest. Remember, knowledge is power when investing.
In the end, angel investing is always a risk. Have the discipline to say no to a deal, and focus on building a portfolio of angel deals over time. By applying this practical advice you can increase the odds that your portfolio will grow over time and reap strong returns.
If you would like to find out more about building an expert portfolio register as an investor or call us on 01 669 8525 to find out more.
This article was first published by Forbes and was written by Marianne Hudson.
"I am an angel investor and Executive Director of the Angel Capital Association (ACA), the world’s leading professional association for angel investors. ACA is focused on fuelling the success of accredited angel investors who support high-growth, early-stage ventures, and has more than 12,000 member angels across North America. I know one thing for sure: there is a method to the madness. In shaping ACA professional development programs and public policy advocacy, I have the opportunity to hear firsthand from experienced angels and the ecosystem at large—what works, what doesn’t work, and strategies to consider for everything from getting started as an investor, to finding great deals, to supporting the companies you invest in to growth and exit. I know about trends and impacts of angels and innovative startups too. Earlier in my career I ran the angel initiative at the Kauffman Foundation, which led to ACA and the Angel Resource Institute, and where I also oversaw entrepreneurial education and mentoring progra designed to ensure that more entrepreneurs develop sustainable, innovative businesses. I love entrepreneurship and have worked in supporting fields for more years than I will admit. I am a member of two angel groups in Kansas City and also connect with several accredited platforms."