The 3 biggest mistakes angel investors make when investing in startups

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. 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 walk through 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 you 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 who leaves you excited, curious and with a fear you will miss out if you don’t move quickly. 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 whom you have just met. They have determination, and 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, to 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 rising 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.