To most people “angel investing” is a rich man’s hobby. A distraction used by Hollywood movie stars like Ashton Kutcher to pass the hours of the day away instead of visiting the casino or playing the stocks.
While there’s a definite potential for financial loss, anybody can (and should) do it.
Google, LinkedIn, Facebook, Twitter, and many other Internet startups were funded by angel investors like Ron Conway, who’s made a fortune investing in startup ventures, using many of the principals listed below.
1. Evaluate the team first…
Notable angel investors like Tej Kolhi, Tim Ferris and Ron Conway all stress that the team has to be evaluated first, before you look at the books or market potential.
This is also one of the hardest things for a new investor to do. If you’re in the habit of watching shows like Dragon’s Den and The Shark Tank, you’ve learned the importance of scouring each startups’ financial statements to see what’s going on below the surface.
In fact, leadership is usually at fault when it comes to financial problems (though not always). If a good team, who seems to genuinely care about the company’s success is already in place, then you’ll know the company’s worth digging into further.
2. Are they profitable and self-sustaining?
In most cases, the money has to come a close second. If you’re looking to invest in a startup that will bring in untold dollars for the forseeable future, they have to prove they’re capable of turning a buck. Even if they’ve only made a hundred dollars profit, that can still be a good sign.
3. Can what they’re asking for help them reach a milestone?
This is where you have to be a really good junior accountant; or have a trusted one at your beck-and-call. The startup needs to have a firm plan as to what they’ll do with yours and other investor’s money.
How much do they need – what are they going to do with it – where will the company be as a result of your cash infusion in a month; three-months, six-months; a year, etc.?
If your investment can’t cause forward movement, walk away! Scour the financials for references to the company’s break-even point, as this is a good marker to determine if/when they’re capable of reaching profitable milestones.
4. Assess their market advantage
The worst thing you can do is to let your opinion about the company or their products get in the way of determining whether it’s a sound investing opportunity or not. Compare Robert Herjavec to: Kevin O’leary, Damon John and Mark Cuban on Shark Tank. Each are decidedly rich men, but the latter 3 make decisions based on the business’s profit potential, whereas Robert (the poorer of the 3) rarely invests in anything unless it’s something that tickles his personal interests.
Successful startups become successful because they have something that nobody else does, or they do it considerably better than and/or cheaper than the competition.
This part of the equation is equally dependant on the team and product, unless you’re investing in the last remaining goldmine or oil refinery left on the planet!
5. Converting note or equity?
Most of the investment programs you’ll see on television involve billionaire investors purchasing a “percentage stake” – equity in a chosen company. This is just as it sounds: if the company’s valuation is set at $2M dollars and you invest $500,000 then you would own 25% of the company. This is a generalization, but it gets the point across.
For most startups with an uncertain future a “converting note” is the most popular way to invest your angel money. Converting notes are used when both the investor and startup entrepreneur cannot agree upon an exact valuation number for the company. Money is invested, and both parties agree that at a set milestone when an accurate valuation can be determined, the note will be “converted” to a set amount of equity, or returned to the investor, with interest.
Both types of deals have their advantages, read more about what type to choose in the links provided:
http://www.startups.co/learn/angel-investment-deal-structures
Ready to get started?
There’s plenty more you’ll learn as you start to invest your money in startups. If you’re careful about your choices, angel investing can be very profitable and interesting; maybe even lead you on the road to riches.
Take a word of advice from Tim Ferriss:
He says to spend your money angel investing in the same way you’d allot a budget for a fun night at the casino:
“Startups are speculative, and this is gambling. You shouldn’t invest anything you’re not comfortable kissing goodbye. Treat it as casino money.”
Now, if you’re a degenerate gambler, that might not be the best advice for you, but hopefully you all get the point!