The 3 biggest mistakes angel investors make when investing in startups

The 3 biggest mistakes angel investors make when investing in startups

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    What does success look like for an angel investor?

    Is it investing in a unicorn like Uber? Or maybe investing in entrepreneurs from your community. Is it directing more funding to female founders? or maybe successfully raising a VC fund off the back of your track record?

    To be honest any of the above could be true for you. It all comes down to your motivations.

    Let’s take a look at what Harry Stebbings, General Partner at 20VC thinks

    Andy Ayim, founder of The Angel Investing School replied:

    In Harry’s post, we can see as a Venture Capitalist his motivation is about making a return from his portfolio of startups. So his advice to angels is really motivated by his VC experience. 

    However, Andy rightly pointed out that Harry’s post represents just one motive, which may or may not be yours.

    Angel investing is personal finance. Big emphasis on the word personal. Your personal motivations drive what success looks like for you. 

    Nevertheless, despite the many different motivations and visions of success, all angel investors are vulnerable to making the same mistakes.

    Throughout this article, we will walkthrough the 3 biggest mistakes. 

    One of the biggest mistakes we see beginner angel investors make time and time again at the Angel Investing School is the misallocation of capital. New angels are often so passionate and keen to invest in their first startup that they forgo some of the most crucial fundamentals of investing.

    We see lots of excited angels who set off on their journey and either invest their money too quickly, invest money they don’t have or have no money to follow on their successful startups. 

    Do not panic though. Capital allocation is the most challenging aspect of angel investing and we want you to get it right! Below are the 3 most common mistakes angel investors face when allocating their capital and how to avoid them.

    1) You invest your money too quickly 

    Becoming an angel investor is a very exciting time. There are so many different types of founders, startups and ideas in industries you have probably not even thought about. It is easy to fall into the trap of wanting to invest in every founder who shares with your their revolutionising startup idea. We get it! Staying rational and disciplined is the hardest thing for a beginner angel investor. However, what happens if you spend all your money at the beginning of your angel investing journey there won’t be any left. 

    Imagine you saved up £30,000 of your hard earned cash and started angel investing, you meet an inspiring founder that leaves you excited, curious and with a fear you will miss out if you don’t move quick. You decide to invest £15,000 (half your saved pot for investing) because you REALLY believe this will be the next big thing.

    This is a rookie mistake, but a common one that is so easy to make. We don’t want that to happen to you!

    How to avoid this mistake:

    This is probably the hardest mistake to avoid but it’s important to be disciplined with your capital. Take your time before writing your first check. Join a few due diligence calls to get a feel for some of the key questions that more experienced angels ask before making a decision to invest. Speak to a variety of founders to get a feel for the types of different founders that exist. Speak to a variety of angels to understand their perspectives and learn from how they think and make decisions.

    As you get more experience you will naturally become more disciplined with your money so do not rush your angel investing journey. We also recommend, do not set yourself targets when you want to invest. You will know when the time is right. Most importantly don’t force it and don’t let FOMO (fear of missing out) dictate your investment strategy. This rarely ends well for investors. 

    You will miss out on great deals, but don’t forget every year is filled with new opportunities to invest.

    2) You invest money that you don’t have

    Another golden rule we remind our community members at AIS is never to invest money they don’t have. What we mean by that is that don’t invest your life savings into a startup that you think is going to give you a 100x return and a few months later that startup goes bust. Thinking back to the statistics on how likely a start-up is to succeed (1 in 10), as an angel investor, you should never invest money that you don’t have. Even if the startup you invested in is successful, remember that your investment is going to be tied up for years and you are unlikely to see your money in the near future.

    How to avoid this mistake:

    Make sure that all your bills, necessary expenses such as your mortgage or rent, bills and living costs are paid for before spending any surplus money on your angel investments. Only invest from your disposable income. For example, you saved some money to buy a nice expensive jacket? Instead of buying this jacket, consider using this money to invest in these amazing founders that you have just met. They have determination, strong product-market fit and operate in a growing market (always do your due diligence!). That sounds like a great trade-off! The key to remember is, NEVER invest money that you cannot afford to lose. We want angel investing to be a source of joy for you and not stress.

    3) You have no money to follow on your successful investments

    There are a number of strategies that you can implement as an angel investor when it comes to structuring your investment portfolio. There is the “spray and pray” strategy for example, where you invest capital in as many startups as possible and hope that a few will succeed. However, a more common strategy that is seen amongst angel investors is diversification and saving some money as a follow-on to avoid being diluted down the line by larger investors such as Venture Capitalists and Private Equity houses. This is because follow-on investment is necessary to avoid having your shares diluted and long-term returns eroded. This is why avoiding mistake #1 is key because if you spend all your money at the beginning of your angel investing journey, you have no money as a follow-on to your successful investments. 

    How to avoid this mistake:

    Avoid spending all your angel investing money at once. Make sure you keep some money aside to invest in your successful startups when they are raising again. Having follow-on capital is important because it allows you to maintain your equity stake, not get diluted and hopefully eventually make some healthy returns. As a rule of thumb, use the 50/50 rule. 50% of your angel investing pot will go to initial angel investments and 50% will go to your follow-on investments.

    Jason Calacanis was able to turn $100,000 into $100 million through angel investing. If he did it, why can’t you right? wrong.

    Remember, angel investing is a risky business, so even if you avoid the 3 most common mistakes we listed above, it doesn’t guarantee you will make a return. This is why we put so much emphasis on having the right motivations upfront in order to manage your expectations. Making a return is your best case scenario, but please don’t forget what the worst case could be. Get comfortable with taking the risk and investing if the worst case scenario plays out. Just make sure that the worst case doesn’t involve you allocating too much capital, investing what you can’t afford to lose or not saving enough capital to follow on with your winners.

    I hope this article helped you to rethink your capital allocation strategy and you have learnt a thing or 2! Interested in learning more about effective capital allocation for angel investors? 

    Check out our community, programs and membership here. Most importantly if you join our community, you will never be alone on your angel investing journey.

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      E-book: Analysing Startups the Marc Andreessen Way - The Onion Theory of Risk

      Learn these 11 key risk frameworks from a legendary VC

      Marc Andreessen has grown Andreessen Horowitz (a16z) from a $300 million fund to over $25 billion in just 10 years.

      ✅ Enhance your due diligence questions and decision-making when speaking to founders.

      ✅ Understand the key risks faced by founders and how you can help to reduce them.

      ✅ Ask founders better questions before making an investment.

        E-book: Analysing Startups the Marc Andreessen Way - The Onion Theory of Risk

        Angel Investing 101: What is angel investing?

        Angel Investing 101: New to the world of angel investing? Start here

        There is a wide range of assets you could invest in today, a few include:

        • Cryptocurrencies like Bitcoin
        • Stocks and shares in publicly listed companies like Apple
        • Real estate like a house you purchase to rent on Airbnb
        • Classic cars like a vintage Aston Martin
        • Prestige watches that hold their value such as a Rolex
        • Art masterpieces such as a Bansky painting
        • and the list goes on…….

        With any investment you make, there is a risk you could lose your money or potentially you could make a return on the money you have invested.

        Let’s walk through a simple example:

        If you invest £1,000 and after a period of time you receive a 2x return, that means you would receive £2,000 as a return i.e. you have doubled your investment. In this scenario, you made back your initial investment of £1,000 with a profit of £1,000 on top. Not bad! This is of course a simplified example not including things such as transaction fees but this is the basics of what it means to make a return on your investment.

        An angel investor sometimes referred to as a business angel is an individual that invests in privately owned small businesses (startups). The investors can choose to leverage their experience, expertise and network to add value and support the company through growth. They receive equity in exchange for this investment with the hope to share in the returns if the company experiences a liquidation event such as an IPO (initial public offering on the stock exchange) or acquisition from another company (trade sale).

        Many initially disqualify themselves from investing in startups because they believe they can’t afford to. With the advancements of modern technology, you could invest a few hundred pounds in startups on Equity Crowdfunding platforms such as Seedrs, Republic and Crowdcube. Check out how VC investor, Henrik from Playfair Capital got started initially through investing on Equity Crowdfunding platforms.

        Contrary to popular belief angel investors can invest as little as a few hundred pounds in startups to be considered an angel investor. Another key characteristic is that angel investors invest their own money compared to for example Venture Capitalists and Private Equity houses who manage and invest money they raised from their Limited Partners

        Angel investors usually invest their own money into a start-up in exchange for an ownership stake in the company, also called equity. Equity is defined in simple terms is defined as ownership of a company. If you get 20% of equity that means you own 20% of a company. This is the most common type of monetary exchange between founders and angel investors. There are different types of funding structures that investors can offer to founders, however, such as convertible notes (promise for future equity at the next priced funding round).

        In addition to providing a new business with capital, angel investors also support founders with other resources such as access to important contacts, mentoring and advice which can be valuable resources for startups. When first-time founders set off on their start-up journey, they often need support with critical business decisions. This is where angel investors can provide significant strategic value. For example, a founder is looking to hire a software engineer and as an angel investor, you can support your founder in this process by helping them during the recruitment process or referring a great engineer from your network. As mentioned, there are many different types of support angel investors can provide. This is also called the added value of an angel investor.

        Ready to level up your angel investing game? Join 1000+ angels in our newsletter.

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