Gen Z Angel Investing: The Small Check Approach š¼
āAngel investors are often retired entrepreneurs or executives, who may be interested in angel investing for reasons that go beyond pure monetary return.ā As is often the case with Wikipedia, this information is directionally correct but missing the whole truth. While historically angel investors have been incredibly high net worth individuals, in recent years weāve seen many companies innovate in an attempt to democratize startup investing. Platforms such as AngelList and Republic have begun utilizing SPVs (special purpose vehicles) and equity crowdfunding to grant deal flow to what had previously been accessible to only a select group of high net worth individuals, and the meme generation of entrepreneurs and investors has enthusiastically aped in.
During the pandemic I joined these young degenerates in exploring the realm of private markets. In 2021 I saw more than 250 deals (not including equity crowdfunding opportunities) and participated in 11. The average syndicate participation rate on AngelList this year is~4.2%, so my 4.7% is a little higher than normal.
Thereās no way for me to tell you so early on how my investments will perform, so I wonāt tell you what to invest in. I will instead analyze the pros and cons of small check angel investing so we can establish a framework to determine if startup investing is right for you. Looking back on this past year, here are my biggest takeaways for small check angel investors.
Some Quick Maths š¤
Iām an Applied Math Major at heart, so letās use some basic Fermi Estimation to establish some initial context. Feel free to skip this section if you hate math, it is for nerds.
Iām going to list some initial assumptions here, yell at me on twitter if you take issue with these:
- A part-time angel investor can reasonably stake roughly 5% (moderate risk tolerance) to 10% (high risk tolerance) of their net worth on these startup investments. Notice that thereās no low risk tolerance option becauseā¦ why would you be angel investing?
- Venture Capital works under a power law investment mindset. While there are some key differences from an Angelās perspective (we make fewer bets and with our own capital), the core principle remains the same. In Zero to One, Peter Thiel suggests investing in 7 or 8 companies. However, this advice was from 2014. In the current startup climate I believe we can increase that range without diluting quality, so letās assume we want to make anywhere from 10 to 20 bets per year
- Any Angel Investment less than $25k is likely going to be through an SPV, such as a syndicate or an RUV, and occasionally through equity crowdfunding. Syndicates have an average carry of 20% paid to the syndicate leads, not including any setup costs that platforms might charge
- Per Business Insider / Goldman Sachs, the average 10-year stock market return is 9.2%, while the average S&P 500 return is 13.6% annually. We are ambitious kids, so letās take the higher number as our target to beat
- For simplicity, weāre going to look at a 5-year time horizon. I recognize that for some this might seem too small
Looking at the first 3 assumptions, we can see why this asset class has been historically only available to high net worth individuals. If checks less than $25k were mostly inaccessible prior to SPVs, then taking our highest risk combination with the smallest check size yields us the following equation to determine net worth:
We see that at the very edge of our range (high risk tolerance, low check size) we would have needed a net worth of $2.5 Million to comfortably make a go at Angel Investing. However, with the advent of SPVs, this equation changes:
At a $1k check size, we only need $100k in assets! Note that you still need to qualify as an accredited investor, but when Stripe new grads are averaging $230k a year, there are likely plenty of young tech and finance professionals who fall into this bucket.
Letās estimate some public market returns to set some goalposts. Over 5 years with a rate of 13.6% annually we need to beatā¦
After 5 years in the S&P 500 we expect roughly 89.2% in gains. This goalpost assumes no carry, as is the case withā¦ pretty much just RUVās or Equity Crowdfunding at our check size. Discounting syndicates would significantly diminish the small check angelās deal flow, so letās incorporate syndicates into the mix. Syndicates have an average carry of 20%, when we factor that in we getā¦
Oh dear, thatās a little more difficult to achieve. It appears that if we want to outperform the S&P 500 using small check angel investing, we need to have a 5-year return of more than roughly 136.5% in gains. This doesnāt even factor in platform setup costs ā for example, if a syndicate has 100k allocation with an 8k setup fee, we have to add an additional 7.5% to the carry part of this equation. Itās definitely an uphill battle from the start for the small check kids, but we wouldnāt be here if we werenāt up for a challenge. Letās discuss some more explicit pros and cons with this goalpost in mind.
The Pros š
Despite the high goalposts we set in the previous section, there are actually plenty of reasons to invest in startups.
- Diversification of assets š
Hopefully I donāt have to explain the above to you, but increasing your exposure to different asset classes partitions your risk and mitigates the size of any one failure, increasing the overall fault tolerance of your portfolio. As a caveat, this ignores the collinearity that your private market assets might share with any other assets you hold, but that is a complex rabbit hole that I am not informed enough to navigate.
- Increased exposure to the startup ecosystem š§
One of the lesser known benefits of angel investing is continued exposure to the startup ecosystem. Seeing numerous deal memos, startup statistics, and pitch decks gives you increased insight into the trends in venture-backed companies as well as the monetization/GTM strategies of many startups. If you want to keep your finger on the pulse of whatās hot in tech (definitely Web3 right now), this is one of the best ways to do it.
- Networking & Key Strategic Partnerships š¼
In a similar vein to the above, being an angel investor will often bolster your professional network. Iāve reached out to a few founders I was interested in investing in, and Iāve had great conversations and connections regardless of whether or not I was let into the round. That being said, itās good to keep in mind that at a small check size no founder cares about you. I already had mutual connections with these founders; without those I doubt I would have gotten a response.
Angel investing is also a good way to build key strategic partnerships. While this benefit is generally more relevant for the founders than investors, strategic angels are chosen for either their connections or the businesses they run/work at. If youāre in the latter camp, itās likely that you can build a mutually beneficial partnership between your current work and the company you invested in.
- Potential for incredibly outsized returns š
If youāre familiar with venture capital, meme coins, or daily fantasy sports game theory, youāre likely aware of the power law investment mindset. Investors under this framework are investing with the expectation that most bets will be net negative, but one of their bets will have such an outsized return that it will more than cover the cost of the other bets. If you are investing with this framework, then you should have the expectation that every company you invest in could be the next Doordash, Coinbase, Snowflake, etcā¦
While always true of Venture Capitalists, part-time angels actually donāt need to use this approach (weāre much more comfortable with a 2x return next year than a VC would), but there is definitely an incredible attraction to the concept of incredibly outsized gains. Private markets provide the opportunity to build generational wealth in a relatively short period of time if you make the right bet, while public marketsā¦ well thereās always r/wallstreetbets.
- Professional brand and social capital š
As Alex Danco points out in his brilliant article on the social subsidy of angel investing:
The real motivator isnāt greed, itās social standing ā just like a century ago, with the original Angels who financed Broadway shows. Angel investing is how you stay relevant. Itās how you keep getting invited to things. Itās how you matter.
While your investment in a startup is illiquid for an incredibly long period of time, your social clout gains are immediate. If youāre not bringing up your angel investments casually in conversation at every party you go to, then youāre missing out on some unrealized gains you can cash immediately. Go straight to your LinkedIn (or Hinge for the truly cultured) and update that description immediately.
In all seriousness, there is utility in having a proven track record of picking winning companies, even prior to the investments being liquid. If youāre interested in breaking into venture capital, small check angel investing on your own can provide some relevant experience.
The Cons š
While we have listed some strong pros above, angel investing definitely has many downsides as well, even more so at small check sizes. Letās walk through them so we can decide if small check angel investing is right for us.
- Shrinking multiples š
The current fundraising environment has significantly shrunk multiples on returns (upside). Seed rounds that were once averaging $5M valuations are now seeing medians of around $24M among the top quartile, with prices as high as $50Mā¦ and many are arguably pre-product. In B2B SaaS in particular, standard valuation multiples are currently anywhere from 100ā200x ARR (Annual Recurring Revenue). It has become clear that in recent years private companies were incredibly undervalued, and the private markets are naturally correcting this.
The conventional counterpoint to this is that exits are much larger now, but this point is diminished when you consider that intermediary exits are less likely to scale proportionally. Companies arenāt going to purchase your $1M ARR startup for $150M. Regardless of what side of this argument youāre on, it is clear to all private market investors that the expected returns have shrunk.
- The private markets have significantly fewer regulations regarding disclosures š¶
Itās almost too easy for a startup to paint an incredibly rosy picture for the inexperienced investor, when in reality the company is a moving bus-fire heading towards a cliff. Thereās a reason that platforms such as AngelList make you agree to multiple closing document provisions, including my favorite provision:
I understand that I must do my own diligence, read the investment documents and ask any questions I think are relevant to my investment decision. Company information on the site is incomplete and has not been verified. AngelList, {lead_investor}, and the fund advisor may not have done any diligence on the company. Investing with notable investors doesnāt guarantee any level of diligence has been performed.
There is a 100% chance a startup is not as good as the deal memo and pitch deck make it out to be. Intellectual honesty has always been orthogonal to interpretations of data in the startup world, thatās just the nature of the incentive structure that venture capital has created over the years.
- If youāre not a full-time angel investor, youāre strictly at a disadvantage š°
This is a fairly straightforward point. Whoās going to win ā the person who can spend the hours doing due-diligence on the market opportunity, the founders, and the companyās stats, or the person who skimmed the pitch deck and stalked the founders for 10ā15 minutes? All other factors held equal Iām certainly going with the former. At a check size less than $25k, I would not be confident that I could even meet the founderā¦ which leads into my next point.
- At small check sizes you rarely meet the founder š¤”
Itās worth restating that at a small check size no founder cares about you. If you havenāt already met the founders, your deal flow as a small check investor will often not result in a full meeting, and if you do get the opportunity itās exceedingly rare to meet more than once.
Some might make the argument that with enough hustle, you should be able to prove enough value that a founder will be willing to meet with you. While I agree with this point, this is only relevant for companies where you are already interested in investing. In the decision making phase of small check angel investing, you will not meet the founder. This means all those podcasts you listened to were useless ā you wonāt be able to sit down with the founder, look deeply into their eyes, and know in the first few minutes whether or not theyāll build a revolutionary company.
To understand how much of a detriment this is with regards to selecting early stage investments, let me give you an example. I had the chance to attend a Sequoia Angel Academy presentation earlier this year, where the partner delved deeply into what they look for in a founding team ā authenticity, founder market fit, unique insight, intellectual honesty, resilience, the list went on and on (DM if you actually want the full list)ā¦ Someone then asked in the Q&A portion:
If I canāt talk to the founders, what should I do?
The partner stared for a bit, and then, in an almost wry tone, said,
Well you could look at their LinkedIn.
Incredible, I never would have thought of that ā thanks Sequoia! Let the LinkedIn stalking begin. In all seriousness, my best recommendation for founding team vetting is to look for lines, not dots. Does their track record suggest personal motivation, accomplishment, or resilience? Do you see context specific experiences that would suggest founder-market fit? Utilize the same harsh judgment you would use when stalking a best friendās new significant other.
- SPV deals are self filtering for less popular deals at an early stage š„¶
In todayās hot fundraising environment, VCs are scrambling to get into rounds. Securing allocation for themselves, much less a syndicate, is often a struggle. As a result, deals that you see through SPVs are more likely to be unpopular. Deals that are āled by Sequoiaā deals or āB2B SaaSā¦ led by David Sacks at Craft Venturesā are rare. That being said, to quote one of the hottest rising VCs Mac Conwell on Harry Stebbingās 20VC Podcast:
Hot deals donāt mean anything. The deals that matter are the deals that return capital, and every hot deal we know doesnāt return capital.
Honestly, a lot of people just play āfollow the leaderā in angel investing. The strategy is understandable: lead investors provide the due diligence and the north star that you place your trust in, so when theyāre a tier 1 firm you tend to take their word for it. However, keep in mind that in a power law mindset you often want to go against the grain. Fortunately or unfortunately, the carry structure incentivizes investors to syndicate as many deals as possible, both good and bad. So as a counterpoint, gems likely exist just by virtue of the sheer volume of dealsā¦ you just might have to wade through a lot of bullshit.
Making an Informed Decision š¤
Given all this information about the small check angel investing environment, we can conclude that small check angel investing is only appropriate for some specific profiles:
- Risk tolerant individuals with strong networks and a solid understanding of power law returns
- Future Angel Investors / Venture Capitalists looking to gain experience & build a track record of picking winners
- Operators looking to gain insights into the current startup ecosystem
- B2B SaaS Founders and Executives investing in other B2B SaaS Founders
If you are any of the above, then go for it. I believe that most individuals have backgrounds/experiences that should give them unique insight into different problem spaces, and that the more of those people that capitalize on these insights and invest in startups the better.
However, if you are any of the following:
- Professionals looking for asset diversification with more assured profits
- Anyone too busy to read pitch decks with inflated numbers and liberal interpretations of data
- People looking for a way to get rich without putting in the hours
- Individuals with low risk tolerance
Look to place your money elsewhere. Rolling funds are a nicer, lower effort way to give your portfolio exposure to startups. You would be outsourcing the due diligence and betting spread to another professional willing to spend the hours necessary in exchange for a management fee (0.5ā3%), but you will have to invest on a quarter to quarter basis and you usually still have to pay 20% carry.
There are other alternatives as well. The ODX Community Fund for On Deckās Y-Combinator competitor seems like a particularly nice deal, given the valuation at which they invest in, so I personally invested in that.
I do believe that the democratization of private market investing will continue to progress, so the conclusion here might change over time. I didnāt discuss equity crowdfunding too much in this article, primarily because I found the deals to be lower quality on average, but it is certainly interesting from a consumer business perspective. Consumer startups like Gumroad can now align their customers with the companyās own success in a similar fashion to how B2B SaaS Founders secure strategic angels. Iāll be tracking platforms like Republic as they continue to trend upwards.
There are also other promising innovations in the space such as DAOās (see SyndicateDAO), but the regulatory environment around investing in securities through DAOās is extremely uncertain. Perhaps another article on that once DAOās or something similar in Web3 gains more traction.
For those interested in diving into Angel Investing after reading this, here are some resources I found helpful:
- Jason Calacanis Book - Angel
- Jason Calacanis Angel Podcast
- Naval on Angel Investing ā Part 1
- Naval on Angel Investing ā Part 2
- Paul Graham on Angel Investing
- Harry Stebbingās 20VC Podcast
For increased direct deal flow:
- AngelList Syndicates
- Republic ā Note that Republic also has a Deal Room for Accredited Investors specifically.
- The Syndicate
For indirect deal flow (some of my deals came through these connections) and networking building:
If youāre thinking of starting a company now or in the future, take a look at my article on Co-Founder Dating.
Follow me on medium (@chongz) or twitter (@chongzluong) to continue listening to me shout nonsense into the tech ether.
