Angel Investing: Think Exit Strategy First

Many angel investors in start-up companies really don’t know what they are doing.  Although there are some  smart angels investors who make a good return, I’d say the majority don’t.   However, there is clearly a “coolness” factor to being an angel investor.

If you consider the general rule of thumb among venture capitalists, approximately 40% of the companies they invest in fail.  Another 40% return only the invested capital.  That leaves about 20% that provide most of the returns.  Its also important to note that about 2/3’s of all VC firms deliver returns below what can be achieved in public markets.

So if you consider that VC’s have access to capital, have substantial market and technical knowledge, have a network of resources, and are typically more experienced than angel’s, why would an angel investor believe they can achieve substantial returns.

Investing Gone Wrong

Start-ups are by their nature risky investments and only a few really make it big.  Below are a few examples of angel investing gone wrong:

  • Most angel’s don’t truly understand the technical or market risks of the companies they invest in.
  • Most angel’s get enamored by the founder on how cool an idea and how big the opportunity  is but the angel doesn’t do the detailed due diligence necessary to be fully informed.
  • Most start-ups need additional cash after the initial angel investments but most angel investors don’t have the deep the deep pockets to maintain their investment through its ups and downs.  This leads to either losing there total investment or getting crammed down in future rounds.
  • Angel’s don’t take an active role with their investments like VC’s will.  VC’s typically find ways to help their portfolio companies with introductions, networking, and guidance – not something typical angel’s have the wherewithal to do.

A successful investor friend of mine, Michael Slater who is CEO of Entry Ventures, talks about dreaming or thinking backwards.  This is a powerful lesson for angel investors.  Think first about what an exit will look like.  I’m not talking about the actual  size of the return but what will the actual success factors be to achieve an exit and how will that exit happen.  And make sure your exit strategy in in line with the founders.

Classic Angel Exit Strategies

  • Get acquired by a larger firm that will have a need for the start-ups business
  • Find replacement capital, such as from a VC or from company profits, to buy out early investors
  • Take the company IPO

It’s important to understand the exit timeframe you are targeting as well.  With this knowledge, then you can work with the founders to work backwards to determine what milestones must be reached to reach your goal.

 

 

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