1000 Angels Blog

When it comes to early stage investing, there is so much to learn and an ever-evolving landscape. And there are some great books out there that can help you establish a solid knowledge base in this asset class.

Most people who talk about angel investing or early stage investing in general often accompany it with a stern warning: “Be ready to lose all of your investment.”

And while this is definitely a possibility, we know that avoiding the companies that implode in a spectacular fashion is half the battle to building a portfolio with a strong IRR. For every company that goes completely bust, you need to generate a 2x return from another investment just to break even.

So here are our top ten warning signs to look out for when you are considering an investment.

One of my clients, Jeff, is a high net worth individual who has worked in finance for years. Although he is very familiar with stock market investing, he was a little stumped when it came to understanding the nuances of startup investing.

He was looking at two different deals. Both had great founders, a great market opportunity and some good initial traction. One was raising $2 million at a $10 million valuation and the other was raising $1 million at a $5 million valuation. He wasn’t sure what to do.

“How do I calculate the PE ratios? How do I know what the market cap is going to be?” In short, he needed to know how to evaluate this very special asset class that is a startup investment. And the tools he learned to evaluate public market investments weren’t going to be very helpful to him in this case.

The “portfolio effect” is the decrease in overall risk in a portfolio of high-risk, but relatively uncorrelated assets. In venture investing, it typically refers to the strategy taken by experienced investors of investing smaller amounts of capital into a fairly large number of startups, rather than putting all of their capital into one or two companies.

It is often very hard to predict exactly which of a group of high growth potential startups will end up as the “winner-that-takes-all”, so better risk-adjusted returns can be achieved by investing in a portfolio of 30 high quality companies over time. Even 5 small investments per year is enough to make a significant difference in the expected returns.

Due Diligence may sound like a scary process, but it really just means exercising a reasonable standard of care before making an investment decision. During the due diligence process at 1000 Angels, we get to know the companies we are considering investing in very well. And a lot of that starts with getting to know the founders.

We rely on referrals from other founders, 1000 Angels and experienced investors to help us meet founders that we can trust. If you have meet a founder for the first time and like his or her idea, make sure you do a lot of “asking around” and reference checking before making a decision. Many of the founders we have made investments in we have known for several years before actually writing a check.

There are plenty of great resources on angel investing. Reviewing the 1000 Angels investor video library is a great start. But we also have some books we think you would love to read if you really want to dig deep.

Calculating your expected return on a startup investment can be a complicated process, or as simple as something you can do on the back of a napkin. The simple rule of thumb is to estimate your potential return based on how much you expect the company to sell for. Most investors expect a liquidity event such as an acquisition or IPO within 5-10 years after investing. We will use our best estimate of a future acquisition to envision this scenario.

One of the things that people enjoy most about early-stage investing is getting in at the ground floor of something really exciting. Rather than just analyzing PE ratios and balance sheet strength, early-stage investor are typically investing in the products and technologies of the future.

One of the other things that makes it special, is that you often get to meet, speak with, or even advise the founders that you are investing in. You’re investing in more than just a product or a patent, you’re investing in a team and a vision. You, as an early-stage investor, are literally changing the future!