Are you an angel investor or gambler? V3

 What is the purpose of this article?

Help you identify whether you are an Angel investor or a gambler.

This article does not provide tax, legal, or financial advice.

You must do your own research and fact-based analysis using current and relevant information.

You can download a PDF of this article from: Are you an Angel investor or gambler V3

 What are the critical learnings in this article?

• You may need to create a portfolio of 20 or more companies.
• You might need to invest $800,000 or more.
• You need the skills and time for both due diligence and helping founders succeed. Money by itself is not enough.
• You need to determine if you’re putting capital into early-stage companies because: you are an investor; you are a gambler; or this is a charitable activity and not part of your overall investment portfolio.

How do you recognize if you are an investor?

• The primary purpose of your investments is to grow and preserve your financial wealth.
• There may be secondary purposes such as enabling social good.
• You may have a variety of asset classes. These provide diversification, which may increase the probability of financial return and reduce the probability of financial losses.
• You are tracking the return of your investments.

There are many other ways to spend money, other than investing

• For most people, the major of their spending does not go into investments.
• Hobbies, entertainment, social activities, intellectual stimulation, charities, giving back, and gambling are just some of the ways money is spent. g. I buy 6 lottery tickets a year at $3 each.
• These other activities are not investing. I might win millions with my lottery ticket. Lottery tickets are not where I invest money.
• If the primary purpose of your spending is other than growing and preserving wealth, then that spending is not part of your investing.

What is an angel investment

• An early-stage company may get angel investment before venture capital firms make an investment
• An angel investor may continue to make investments, along side venture capital funds and others, as the company grows.

How do you recognize if your angel investments are actually gambling?

What are the facts?

The following findings are from a 2020 study of more than 10,000 individual early-stage portfolios on AngelList.¹

• Angel investments, as an asset class, generate 15% IRR (combination of realized and unrealized gains)
• Investors who made 1-5 investments had a median return of 0.0% IRR.
• Investors who made 10 investments had a median IRR of about 6%. 32% of these investors lost money.
• Investors who made 20 investments had a median IRR of about 7%. About 16% of these investors lost money.
• Investors who made 50 investments had a median IRR of about10%. About 11% of these investors lost money.
• Investors who made 100 investments had a median IRR of about 14%

Many, if not most, angel investors have a limited return, although the asset class as a whole performs relatively well. A small portfolio of investments has low median IRR and significant chance of losing some or all of your capital.

 How do you change the odds to be an investor rather than a gambler?

There are four ways to be an angel investor rather than a gambler.

#1 Create a portfolio of 20+ investments

This will require significant amounts of your time and capital.

#2 Spend more than 40 hours on your personal due diligence.²

• Spend more than 20 hour of due diligence time for each potential investment.
• Angels who spend less than 20 hours have an average return of 1.1X capital.
• Angels who spend more than 20 hours have an average return of 5.9 X capital.
• Angels who spend more than 40 hours have an average return of 7.9 X capital.

You must consider if you have the skills and knowledge necessary for effective due diligence.  I don’t know the relationship between increased due diligence and the number of investments.

#3 Join an angel investor group

• The rationale is to reduce your due diligence workload, get exposed to a larger number of good opportunities, and learn from successful investors.
• I have no advice on how you can conduct due diligence on an angel investor group, considering its members, its processes, and its potential for future financial success.

#4 Invest in an angel fund

• The fund should have a large number of investments in its portfolio.
• I have no advice as to how you could conduct due diligence on an angel fund, assess management, and determine the potential for future financial success.

How should you think about the amount of capital needed to become an angel investor and not a gambler?

The following example is based on a set of assumptions:

• You’re going to make 24 upfront investments over 1-3 years. As noted above, your median return may be a little more than 7%IRR.  Like that any exits in the first three years will be failures. These early exits may not provide any capital for reinvestment.
• You’ll invest in pre-seed: 75% fail³
• You’ll invest at seed stage, 50% fail³
• You’ll invest in Series A; 50% fail³
• You’re investing at seed and Series A for two reasons: these companies have survived; and later stage investor may impose terms (such as liquidation preferences) which reduce the value earlier investments.
• At each stage, each individual investment is $25,000. In some cases, the startup may have larger minimum cheque sizes.
• Your capital requirement may be: (Pre-seed: 24 X $25,000) + (seed: 6 X $25,00) + (Series A: 3 X $25,000) = $825,000

Often, the seed and Series A investments are large than pre-seed.  This means that your overall capital requirement may range to a $1,000,000 or more.  If you’ve decided to allocate 10% of your investable assets into the angel asset class, your total investments may need to be $10,000,000 or more.

 What are your next steps?

• Define the words/concepts you’re using, in a glossary. I’ve seen major confusion when the same words mean different things to different people.
• You cannot predict the future. The above fact-based analysis is historical. Many changes have occurred in the past few years:  the amount of capital available at the early stage has exploded; many early-stage funds have been created; the number of early-stage investors has grown. You’ll have to determine what the future scenarios could be.
• The angel asset class as whole may do well, but your personal results depend upon your investment process and thesis. Assess whether you have the appropriate skills and time to be an Angel investor.
• Carefully review and understand published reports from investors and funds. Some state their results as including both realized and unrealized gains.
• Make your own assumptions and analysis regarding the amount of capital you’re going to devote to angel investing.
• Determine if you’re putting capital into early-stage companies because: you are an investor; you are a gambler; or this is a charitable activity and not part of your overall investment portfolio.

Footnotes

¹ Nigel Koh, Abraham Othman, “How portfolio size affects early-stage venture returns”, AngelList, https://angel.co/blog/how-portfolio-size-affects-early-stage-venture-returns

² Robert E. Wiltbank, PhD Willamette University, Warren Boeker, University of Washington, “Returns to Angel Investors in Groups, November 2007”

https://www.angelcapitalassociation.org/data/Documents/Resources/AngelGroupResarch/1d%20-%20Resources%20-%20Research/ACEF%20Angel%20Performance%20Project%2004.28.09.pdf

3 “Startups’ success and failure rate in 2023”

https://spdload.com/blog/startup-success-rate/

 What further reading should you do?

How profitable is angel investing? Koor and Associates

https://koorandassociates.org/selling-a-company-or-raising-capital/how-profitable-is-angel-investing/

Your company will fail. Koor and Associates

https://koorandassociates.org/avoiding-business-failure/your-company-will-fail-v1/

How profitable is angel investing? V4

 What is the purpose of this article?

• Share with you some fact-based profitability analysis from the U.S. angel community. I am not aware of similar detailed fact-based based analysis of the Canadian angel community.
• Enable you to think about whether you want to make money as an angel investor and what you might have to do to make money.

This article does not provide tax, legal or financial advice.

You must do your own research and fact-based analysis using current and relevant information.

You can download a PDF of this article from: How profitable is Angel Investing V4

What are the critical learnings in this article?

• Someone making investments in individual angel startups has the potential to make profit if: has the capital to create a diversified portfolio, the time to do due diligence and support the portfolio companies, the talent to select potentially profitable startups.
• Someone making investments in an angel fund has the potential to make profit if: has the time to do due diligence and the talent to select fund managers who will be profitable in the future.
• In either of the above cases, you may need to wait 10 or more years before achieving a cash profit.

 What are the three ways to look at angel investing profitability data?

• As an overall asset class, considering many angel investors.
• As an individual angel group or angel fund.
• The profitability of an individual angel investor, such as yourself.

How profitable has angel investing been in the period leading up to 2007?¹

This study examined the results from of 1,137 exits ((acquisition, IPO, or company closure) from 539 angel investors in angel associations over a 20-year period, with most of the exits occurring after 2004. The average return was 27% (excluding out of pocket costs and assuming zero value for the investors’ time).

Due diligence had a large impact on investor capital returns.

• Angels who spend less than 20 hours have an average return of 1.1X capital.
• Angels who spend more than 20 hours have an average return of 5.9 X capital.
• Angels who spend more than 40 hours have an average return of 7.1 X capital.

Investor knowledge of the portfolio company’s industry had a large impact on capital returns.

• Investors with at least 14 years of relevant industry experience had double the capital returns of investors who did not have relevant industry experience.

Ongoing involvement with the portfolio company (e.g. coaching and mentoring, being the lead investor, serving on the advisory board or board of directors) has a large impact on investor returns.

• Angels who interacted with the company twice a month achieved a 3.7X return.
• Angels who interacted twice a year received a 1.3X return.
• Interacting more than twice a month does not improve returns. The quality and type of interaction was more important than frequency.
• 52% of all exits were at a loss.
• 7% of the exits returned more than 10 times the money invested, and accounted for 75% of the total returns.
• 39% of the investors had portfolios that lost money.
• The top 10% of investors earned 50% of the returns.
• 45% of the startups had no revenue when they received the angel investment.

How profitable has angel investing been in the period leading up to 2020? ²

The data scientists at AngelList analyzed 10,665 investor portfolios (April 2020). The analysis showed that the realized and unrealized IRR for all the investments is 15%. The 2007 study above only examined realized IRR.

The median IRR return for investors is heavily driven by the number of companies in their portfolio.

• 50 company portfolios had a median IRR of about 10%; 11% of these investors lost money.
• 20 company portfolios had a median IRR of about 7%; 16% of these investors lost money.
• 10 company portfolios had a median IRR of about 6% 32% of these investors lost money.
• 1-5 company portfolios had a median IRR 0%.

What has been the performance of some individual angel funds in the U.S. in 2020?

The ACA (Angel Capital Association) Investor Insights report for 2020 shares insights from some large, long established U.S. angel groups.  My article does not name those groups.  You should refer to the report if you wish the names of the groups. The report is available to members of the ACA.

Angel group A analyzed 159 outcomes (exits and shutdowns) since 1997.

#1 A large portfolio is key to large returns

• Equal sized investments in all the companies would have generated 4.8X return.
• 3 of the 159 exits generated 74% of the total return.
• Monte Carlo simulation showed that only 26% of investors with 5 company portfolios would have obtained 4.8X return
• Even with a portfolio of 50 companies, there was only a 37% chance of achieving 4.8X return.

#2 Large returns require investors being able to wait 10 years.

• It takes 4.5 years for investors to get their initial investment back. There are lots of failures in the first few years.
• It takes 10 years to achieve 4.8X return. After 10 years, there is a very modest increase in returns.

Angel group B analyzed the return of their 27 members over 20 years.

• A large portfolio is key to large returns. Investors with 25 company portfolios had 4.5 times the IRR return of investors with 1-4 company portfolios.

How profitable has angel investing been in the United States as of January 1, 2025?

AngelList published the results of the funds on their platform.  The IRR includes both realized and unrealized gains.

• Angel funds launched in 2017: 25% had IRR less than 13.9%; median was 19.7%; 25% had IRR of over 29.2%.  But the actual cash distributed to investors 75% of the time was less than 64% of their investments.  It takes time to make a cash profit.
• Angel funds launched in 2021: 25% had IRR less than -3.0%; median was 1.2%; 25% had IRR of over 6.4%.  But the actual cash distributed to investors 75% of the time was less than 2% of their investments.  This illustrates the J-Curve.  In he first few years of a fund, portfolio companies need capital to grow, which results in future profits.  And portfolio companies fail in the early years.

How useful are performance reports from angel groups?³

• Published results for angel groups often don’t consider the timing and dollar amount of every individual investor action. Assumptions are made because the angel group members don’t share details for every transaction.
• One example of the impact: an angel group reported a 12X return on investments in one company while the return for one individual investor was only a 1.5X return. The 12X return was if you invested day 1.  The individual investor invested in a later round.  The angel group analysis assumed that all investments were made on day 1.

You have the potential to make money as an angel investor if:

• You or your co-investors have deep current relevant market knowledge of each portfolio company’s customers and market.
• You devote significant time to due diligence.
• You remain involved with the company post-initial financing.
• You have the financial resources to create a diversified portfolio of at least 25 companies and to make follow-on investments.
• You can wait 10 years to achieve a significant financial return.

You have the potential to make money as an investor in angels funds if:

You have the talent and time to assess fund managers and be able to pick future high performers.

 What are your next steps?

• Define the words/concepts you’re using, in a glossary. I’ve seen major confusion when the same words mean different things to different people
• Review your overall investment thesis e.g. what asset classes will you be investing in, why, and what expected returns (this includes volatility, and time to achieve returns)
• Determine is angel investing would be a charitable activity or an asset class that is helping you achieve your overall investment thesis. Many angel investors are not interested in financial return, and their angel investments are not part of their financial return focused investment portfolio.
• Define your angel investment thesis.
• Determine if you have the skills, knowledge, and finances to create your own diversified portfolio or if you will invest with fund managers or if you will join a group of angel investors.
• If you are investing with a fund manager, you must do due diligence. It is key to analyze their cash returns over 10 years. I have come across many funds that include unrealized returns.  Unrealized returns are not cash in the bank. You will also have to assess their talent and processes.  If the funds returns are driven by only one exit, you must determine if their overall results have been driven by luck or by knowledge, skills, experience, and processes.
• If the fund manager is just starting their fund or has only been in operation for a few years, then you need to do more detailed due diligence, just as you would for any other startup. If you don’t have deep relevant experience in the fund industry, then you need some with that experience to work with you. Your due diligence focus will be on talent assessment and the fund’s investment thesis.
• If you decide to invest via an angel investor group, you need to do due diligence. You need to assess whether the processes and talent will help you build and manage a profitable long-term portfolio. It is key to analyze the groups metrics and cash returns. One large U.S. angel group tracks 83 (yes 83) metrics for every investment made by a member. Some U.S. angel groups have detailed metrics regarding their members. If the group’s return is driven by one large exit, then you must determine if their overall results have been driven by luck. Assess which members have deep relevant industry experience aligned with your angel investment thesis. Assess the angel group processes. If you don’t already have deep relevant angel investing experience, then you need help from those who have that experience.

Footnotes

¹ Robert E. Wiltbank, PhD Willamette University, Warren Boeker, University of Washington, “Returns to Angel Investors in Groups, November 2007”

https://www.angelcapitalassociation.org/data/Documents/Resources/AngelGroupResarch/1d%20-%20Resources%20-%20Research/ACEF%20Angel%20Performance%20Project%2004.28.09.pdf

² “How portfolio size affects early-stage venture returns”, Nigel Koh and Abfraham Othman, AngelList, https://angel.co/pdf/lp-performance.pdf

³ “How much do angel investors earn?”, DC Palter

https://entrepreneurshandbook.co/how-much-do-angel-investors-earn-1bc06cc8166f#:~:text=Conclusions,from%20a%20single%20huge%20exit.

⁴ The state of U.S. early-stage venture and startups: 2024, Angellist January 28,2025

https://www.angellist.com/blog/the-state-of-us-early-stage-venture-startups-2024The

What further reading should you do?

Are you an angel investor or a gambler?

This article contains an example of the capital you need to be an Angel investor.

https://koorandassociates.org/selling-a-company-or-raising-capital/are-you-an-angel-investor-or-gambler/