Angel investing is hugely appealing to many people because it has the promise of mind-boggling returns. There are a ton of stories about people putting $10,000 or $25,000 into a startup and getting back millions — even tens of millions — of dollars.
There stories are not false, but they are obvious edge cases. What are your chances of investing in a Unicorn?
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What are your chances of investing in a Unicorn?
I’m going to guess there are probably 10,000 projects angel funded in technology per year (say 5x the number of venture deals per year, which I understand is around 2,000 here in the USA).
If there are 10 angels in each deal (another guesstimate), that means 100,000 angel investments get put into this bucket per year. Over 10 years we have 1,000,000 swings at bat by angels.
If we have 40 unicorns every 10 years here in the USA there are 400 angel lottery tickets (40 unicorns with 10 angels each) in the 1,000,000 lottery tickets issued.
By this absurdly incorrect math, you would have .04% chance of getting a lottery ticket: 1 in 2,500.
Interestingly, the original article on unicorns said it was 1 in every 1,538.
If your investment in a unicorn were to go 500x it might not be worth doing those 1,538 (conceptual) investments! Why? Well, if you put $1 into those 1,538 startups and one was a unicorn that paid you 500 to 1, you would still need to return $1,038 on the 1,537 bets. If 70% of those fail, you’re actually trying to make that return on the 461 startups that didn’t die.
The Rub: Access
The big rub in all this is that you have to get access to the unicorns as they are born. Well, if you look at unicorns in recent history, Airbnb & Dropbox came out of YCombinator, and you would probably have a hard time getting to them. I can tell you that Uber was circulated among the folks the founder knew well. My second unicorn, Thumbtack, was actually accessible and many of my friends passed on investing in it!
So, it’s possible, but very unlikely that a “civilian” — in this case defined as someone who isn’t here in the Valley doing investments for at least five years and 50 investments — would ever get in.
Outside of Unicorns
Now, if you have some level of access in Silicon Valley to the best deals, I actually think there is a case to be made for putting 1–5% of your net worth into angel investing.
Here is a model:
1. You have a net worth of $3,000,000 and you put 5% / $150,000 into angel investing over 30 deals at $5,000 each.
2. Two-thirds of those die and return nothing, so you’re stuck $100,000 out of the gate.
3. Of the remaining 10 that don’t die, let’s say you have five that return your money ($25k!) for a push and the remaining five do five times their money ($25k x 5 = $125k). Congratulations you’ve now broken even!
I actually think that the scenario above happens to many angel investors during their first couple of dozen investments — and that’s OK. To break even, learn, and have an outside shot of one of your investments returning 50, 100, 500, or 1,000x is awesome.
In the chance that one of those $5,000 went 100x you would have absolutely crushed it.
A. If you don’t have access to these companies you will never get anywhere near to what I consider a fighting chance. Doing this in Austin, San Diego, or Europe? Good luck!
B. In order to invest in 30 companies you would need to have met with at least 10x that. So, do you have the time to meet with 300 startups? Do you even want to?
C. You have to be wanted by the founder. What do you have, in a world of unlimited capital, that these awesome founders need?
That last point is critical. If you’re coming into angel investing in 2015 you’re up against people who do this full-time for a living. You’re coming up against incubators with huge networks and knowedge they offer founders.
You have to be very careful that you’re not seeing the deals that everyone else said no to. That’s what I think happens to a lot of angel investors: they fund the folks who were unfundable by the pros.
Then they are left with a really sour taste in their mouths, because they now have an investment with a founder who might be insane or incompetent — maybe both!
One great way to get started is by participating in incubators (TechStars, Rock Health, AngelPad & YCombinator are all excellent), AngelList Syndicates (Gil Penchina is the most active one, but Cyan and Scott Banister are also notable) and being an LP in a smaller fund (i.e., Homebrew or Freestyle Capital).
Drafting off of those entities will get you into better deals and help educate you.
Angel investing is a fun thing to do and if you keep it to 1–5% of your net worth I think there is little downside. If you lose half, all, or some of your money it’s not the end of the world, and if you break even or make a modest return you’ll learn something.
All while having the chance to hit a lottery ticket.
Angel investing is gambling in the same way poker is: it involves a lot of skill and discipline on top of the luck.