Angel investment heuristics

(as of 2017/11/09) This document is a draft for personal use and contains lots of copy/paste from various sources. I’m happy to share it online and hear any comment you may have.

Portfolio

Total amount

  • Don’t commit more than what you can afford to lose
    • No more than 10~20% of net worth

Individual amounts

  • Early on, make the same investment size by company
  • Usual amount (in Japan): ¥1~¥5M
  • Save some money for follow-on
    • Follow-on when a new experienced investor leads a new round in the company at a higher valuation

Nb. of investments

  • Large portfolio (many investments)
    • Don’t invest in less than 10~15 startups (over time / 10 years?)
      • Better aiming at 20~30
      • 9/10 startups will fail (on a good day).
  • Make at least 3~4 investments a year (not optimal number, a minimum)
  • Consider mixing syndicates and direct investing

Field

  • When making a small number of investments, play the field. (specific industry or sector)
  • Only invest in sectors you have a domain knowledge (your unfair advantage)

Timing

  • INVEST EARLY (in some cases before product/market fit) at LOW COST in people you think are smart and have built some promising products. understand if they know how to iterate and use customer feedback to improve their product and/or marketing. Learn how to understand conversion metrics for their business & customer value.
    • Then IF you see the metrics improving & customer / business value increasing… then DOUBLE-DOWN.

Sourcing

  • Focus on improving your angel brand and reputation at all cost
    • Build brand by sharing insights freely (Blog, Tweet, Speaking at conferences, Help VCs, Mentor at accelerators etc.)
  • Cultivate relationships with VCs who can send you deals they are not interested in (at the moment, but might be down the road)
  • The best time to say no is before you take a meeting.

Exit

  • Access to buyers: relationships with eventual buyers of portfolio companies.
  • Cultivate relationships with VCs who can follow your investment at later rounds
  • If failure, always conduct post-mortem with team: postmortem will be to identify factors that contributed to the project’s failure and use the information learned to mitigate risk to future teams.

Startup

Profile

  • Simple to understand
  • Solve a real problem
  • Apply the Power law: pick companies based NOT on who is highly likely to be successful on a low level, but on who has a SHOT at being one of the mega winners.
    • Power law: (3/717) 0.4% of Y combinator’s companies make up for 78% of their portfolio’s value.
    • Simple maths:
      • Invest 1.5M in 30 companies: 20% do 5x and 5% do 10x; the rest fails:
        • Total invested = 45M
        • Total return = 67.5M
        • Net = 22.5M
      • Invest 1.5M in 30 companies: 1% do 500x; the rest fails:
        • Total invested = 45M
        • Total return = 225M
        • Net = 180M

Market & Business

  • Fits an upcoming market trend
  • Best investments have high technical risk and low market risk. Market risk causes companies to fail.
    • In other words, you want companies that are highly likely to succeed if they can really deliver what they say they will.
  • Differentiation (no direct competitor / hard to copy)
  • Can raise prices without losing business to a competitor
    • (1) Is needed or desired;
    • (2) Is thought by its customers to have no close substitute and;
    • (3) Is not subject to price regulation.
  • Does the business has something people need or want now and in the future (demand), that no one else has (competitive advantage), or can copy, get away or can get now and in the future (sustainable), and can these advantages be translated into business value?
  • Strong partnerships with corporates

Financials

  • Sustainable business model (run the numbers)
  • Has recurring revenue
  • Does it offer the possibility of at least a 5x return?
    • Look at comparables (similar companies) that have sold, and their average purchase prices.
    • Most of your start-ups will fail, so the successes need to make up for losses.
    • Each start-up, if it exits at 5x its current valuation, should be able to cover 2/3 of your total fund.

Related questions to ask founders

  • How much capital are you raising?
  • How long will that capital last?
  • What will be your monthly burn rate?
  • Do you have detailed financial projections for the next two years?
  • What are the key assumptions underlying your projections?
  • What key cost components are there for the product or service?
  • What are the unit economics?
  • What are the likely gross margins?

Team

  • Choose people, then the idea, etc.
  • Number of co-founders: 2~3 ideal (one should be able to build, another able to sell)
  • Team background (can get along)
  • Team skills (all basics are covered, include a sales)
    • If it’s a single founder, the founder must be technical. Two technical co-founders and one sales is ideal.
  • Important Soft skills for founders: intelligence, energy, and integrity.
  • Team experience and age
    • No young people
    • Invest more in women or older men than young men.
  • Founders need to understand the ecosystem in which they play.
    • What recent companies have sold for what amounts? Who are the most likely acquirers? Who are the most formidable competitors, and what types of funding (even investors) and resources do they anticipate needing to compete?
  • Founders must pass the “mall test”: if you were to see them in a mall, would you walk in a different direction, would you walk over to say “hi” and move on, or would you invite them to join you for coffee or whatever you’re doing next? If the founders don’t fall in the last group, don’t invest.
  • Do the founders actually test some of what I’m recommending?
    • I will usually suggest 1-2 elements for testing in an initial meeting, well before investing, and if at least one element isn’t tested within a week, they’re out.

Related questions to ask founders

  • Who are the founders and key team members?
  • What relevant domain experience does the team have?
  • What key additions to the team are needed in the short term?
  • Why is the team uniquely capable to execute the company’s business plan?
  • How many employees do you have?
  • What motivates the founders?
  • How do you plan to scale the team in the next 12 months?

Marketing & Sales

Related questions to ask founders

  • How does the company market or plan to market its products or services?
  • What is the company’s PR strategy?
  • What is the company’s social media strategy?
  • What is the cost of a customer acquisition?
  • What is the projected lifetime value of a customer?
  • What advertising will you be doing?
  • What is the typical sales cycle between initial customer contact and closing of a sale?

Supporters

  • Renown Advisors & backers

Personal

  • Better if I’m myself eager to use the product (able to verify the market).