Investing in early stage startups

Thinking about doing “some angel investments into startups”? This requires a different mindset than investing in for instance stocks or bonds.

Uber, WeLabs, 8 Securities, Tesla, Angry Birds, etc, imagine you were an early stage angel investor in one (or more) of them.
Granted, they weren’t overnight successes of course, most

of those companies are 4+ years old now, but you could have made a huge difference for them with only US$10,000 or US$50,000 and now have ended up with some very valuable early stage equity. Of course most of the startups doesn’t become multi-billion dollar companies, they can still become multi-million dollar companies.

Depending on where you are from, angel investments can be seen as helping your nephew set up shop to writing the first cheque to Google (Peter Thiel). But if you look closely, the 2nd word in the phrase is investments. Investments are expected to make a return. Experts have been cautioning everyone about low growth environments for a few years now. In search of this elusive growth, one doesn’t have to look much further than angel investing.

The biggest challenge with startup* angel investing is that early stage investment in technical or digital innovation requires a special mindset and knowledge. This mindset is much different than investing in stocks or bonds or investing in established companies. Not even your constantly cooking nephew and his new shop are comparable. Primarily because most conventional metrics, analytics and models don’t work on a pre-revenue startups.

*Startups definition: “A (temporary) organization formed to find a repeatable, sustainable and scalable business model, ready for hyper growth”*

By this definition, a new ecommerce website selling wine (proven business model) and the corner barbershop (not ready for hyper growth) are not startups. They can still be viable and lucrative lifestyle businesses, but they aren’t innovative startups and require a different set up . A website giving away free wine because they found another business model (someone else other than the consumer is paying for it, think advertising/selling the data/etc) is a startup again. This usually doesn’t work well for physical products and works better for digital products like Google, Facebook, Pokemon Go, etc…

Because most innovative startups follow the Lean Startup Method they know how to work with small budgets, be frugal and still crunch out an immense amount of work to validate their business hypothesis. The term “fail fast, iterate and execute again” is common. So small angel rounds of US$100,000 – US$250,000 in total from 2 to 6 angel investors can take a validated business idea to the next level: “revenue”.

Whereas technical innovation often requires (a lot of) upfront investment, digital innovation doesn’t always need a lot of upfront investment, but both can be a great ROI when you know what to invest in.

So how do you know where to invest in when the “company” has no revenue, no track record, no collaterals? I have a few things on my check list when a startups comes to me for angel investment or when high net worth individuals or family offices ask me to look at an opportunity.

1) Team

How does the founding team look like? A team needs 4 competencies: Business knowledge, Technically strong, Marketing savvy and design/user experience focus. Are they full time? What is their background? Industry experts? Etc.

2) Market

What does the market they are after look like? Size, yes size matters, but not per definition have to be enormous. Who are the incumbents? Or is it a totally new market? How tech savvy are the (potential) users? What would it cost to acquire a user? And what could you make off the user during his lifetime.

3) Product

Quite often people look at the product first, but YouTube started out as an online video dating website, Uber as a limousine hailing service, etc. It’s often hard to predict where the product will be in 1-2 years, but usually it’s still the same team with great execution powers and in the same/similar market. Although the product/solution is important, 1 and 2 get higher weighted in my reviews, because great teams in good markets will find a (iterated) product that will stick with their users.

After selecting an opportunity, the question always is: how much should I invest and what would I get in return? First of all, the founders usually are raising an amount with a specific milestone in mind, for instance the development of a feature, the launch of a product, additional research, etc. So founders should be able to tell you exactly where they are going to spend that money and why. So the total amount of investment (round) is often set by the founders. How much of that amount you are taking up is up to you. What you get in return is usually also set by the founders. Due to the relative youth of the startup, it is often hard/impossible to set a value on the company, that’s why often early stage financing rounds are done with convertible notes.

An angel investor usually brings more to the table than money. There are 2 types of money: smart money and dumb money. Smart money is money coming from investors that have knowledge that can help the startup in their business/market/growth. Dumb money is money from investors that are just too busy to help a startup or have no value add, but believe in the team/market/product. Both Types of money are needed for a startup, because often an angel round cannot and should not be filled with smart money alone, too much “investor management” for the founders.

Although smart money is good, an angel investor should not interfere with daily operations, you won’t do that at Akzo Nobel either, you believe in the team running it. I recently had dinner with a founder and one of their investors called, asking about daily operations and it was the 2nd time that week. (the investor is getting nervous because there is a competitor entering the market) Maybe understandable behavior, it isn’t helping the investor/founder relationship and isn’t helping the startup innovate better.
Good founders update their progress to investors monthly with an email or (smart money) over coffee. And they will reach out to you if they need you. It’s a long way to acquisition or IPO so don’t get nervous. On the nervous part: an angel should also not invest the college funds of their children. That’s what Venture Capitalists do, they invest for their paycheck. Angels should invest because they like helping entrepreneurs, want additional returns on their capital and don’t mind taking risks.

Interested in the wonderful world of startups or wondering if investing in early stage startups is something for you? Feel free to reach out and we can discuss more over coffee.

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