Sometimes I get asked what it takes to be an angel investor. It also leads to insight into whether or not being a venture capitalist is the right career. While I am not an expert at either, I do have some observations from the many months I spent trying to raise a venture fund and now ending up as an angel investor. These observations are by no means complete or exhaustive, but for now I think they serve as one man's look into the world of investing in startups. These are the results of conversations, feedback, and personal thinking and experiences:
What Does it Take to be a Venture Capitalist?
Beyond that magical ability to pick companies/businesses/the next Youtube, there are a number of things to be aware of.
Investors need to trust you. They are handing you their millions of dollars and want to have maximal assurance that you'll not run away with it, make stupid or poor investment decisions, keep to discipline (which is what you sold them on investing in your fund), and want you to do better than the next guy.
If you've created companies and built them to success, that's a plus. But it's only one piece of the puzzle. Building a great company doesn't mean you can go and pick other companies that will win. Investors like to see that you have engaged in activities that show you can pick successful companies AND make lots of money from it. The 'AND' is important; just saying "I knew Youtube was going to be big" isn't the same as saying "I bet on Youtube when they are two guys in a garage, put my money in it, helped them with XYZ when they needed it, and saw the potential and put my own money where my mouth was, and made 10X on my investment."
How to develop a track record? Angel investing helps, as does working in investment banking or some other similar investment outfit. If you've worked with other prominent investors like in an angel network, that's great too. People who have invested alongside you and made money off your introduction of a company to them is a great trust builder. Experience as an entrepreneur also helps but not as much as (successful) investing experience. (Working in a previous venture fund helps a lot, but hey this paragraph is about whether or not you should be a VC in the first place.)
If you are thinking of joining a venture fund, they need to also trust you, see your commitment, and they have to like you and be able to work with you.
Joining a venture fund is not like taking a job at any other company. With a regular company, you can quit at any time and go to a new company. The commitment is typically 5 years, with potential to extend to 10 years if you still have companies in your portfolio that you have not exitted out of. This is spelled out in the Private Placement Memorandum (PPM) and is a condition for investors to commit. If you decide to leave the fund before the 5-10 years are up, this can, at a minimum, cause uncomfortable questions in investors minds as to the viability of the team they put their money in. It can, at a maximum, cause all the investors to bolt and your fund is left with nothing.
Therefore, venture fund partners want to know that you're in it for the long haul no matter what. It's pretty tough; 5 years is a really long time to commit. You'd really have to want to do it that long and the moment a partner smells wavering commitment, they'll back off you.
Since you're in it for a long time, you want to know that you can all work together and also must like each other. Again, 5 years is a long time to be hanging out with someone. You'd better all be drinking buddies as well as love working with each other to stand each other's company. That is why a lot of venture funds are made up of partners who have known each other for a long time and have worked with each other in the past. Investors like this also; they want to have assurance that the team can function together well and prevent an unrecoverable implosion of the team at some point in the future. They want to know that the team will exist long enough to make them money for the period of time they commit.
Lastly, almost all venture funds require the partners to put up their own capital. I've heard 1% is the norm, but I've also heard it can be higher as well. Doing some quick math - if your fund is $100 MM, you would need to put up 1% of $100MM which is $1 MM of your own cash. It doesn't have to come all at once; venture funds do capital calls when an investment is imminent. So the cash would come in portions as you went out and found companies to invest in. But over 5 years, you'd have to find $1MM to invest. All is not lost; a venture fund has many partners, so the 1% is spread out amongst all the partners. Still, it could mean many 100s of thousands of personal money to commit to the fund, in order to gain trust of the investors. How many people have that kind of cash lying around?
So after reading this, does the above apply to you in the positive sense, if you aspire to be a venture capitalist?
What Does it Take to Be an Angel Investor?
Simply put, being angel investor requires nothing more than cash. I don't think there is any other requirement than that. Of course, if you want to be GOOD at it, you'll need more than that. Read on..!
Things That Apply Both to Angel Investing and Venture Capitalists
Beyond those mentioned above, you will need to be able to pick companies well. The topic of picking companies is beyond the scope of this post, but no matter whether you're an angel or a VC, you have to do this well. You'll probably want to have some expertise in the area that you are picking companies in, like for me I work on Internet companies because that's what I know most about.
Having an extensive business network really helps. Connecting your entrepreneurs with the right folks will help from a company building standpoint, and even potentially on generating an exit at some point in the future. When you are calling on your friends or previous business associates, it works much better than going in cold. They already know you and there is a level of trust built already.
You also can't be risk averse. You need to be more of a risk taker and be able to get behind an entrepreneur, even when there seems to be no intellectual proof that it will be successful. Startup investing is not for the conservative soul; you'll drive yourself crazy if you are conservative by nature.
The Money Aspect
Here is where it differs slightly between venture capitalists and angel investors. When you are a VC, you are playing with other peoples' money; when you're an angel, you're playing with your own money. I say 'slightly' because in the case where you have to put up your money into the fund, then you'll also be playing with your own money as you invest the fund's money.
But with a fund, the bulk of the money you're investing is not yours. So if this is true, you need to feel some kind of fiscal responsibility to that money, and not feel that you can just take unnecessary risks with it. After all, these people entrusted you with their money on the assumption that you wouldn't just piss it away on stupid investments.
When it's your own money, other things come into play. I'll throw some out there which I think are important.
Most financial planners say that you shouldn't put more than 2-3% of your assets into any one investment. This ensures diversification minimizes the impact of any one investment in case of a downturn in that investment. In either case of whether you're committing money into a fund or designating it for angel investing, is that amount larger than 2-3% of your total assets? If it is, you are potentially taking too high a risk with your assets. Investing into these types of companies is not a sure thing. The potential is greater than zero that you could lose it all.
Still, it has been shown that statistically speaking, if you put money in 10 investments, about 6 will tank, 3 will break even or make back a little, and the last one makes back everything you lost on the previous 9 and then some.
Let's do some math: say you put $50K into 10 companies because you want to employ this diversification concept to maximize your chances of making money. That means you need $500K to do this. If we say that we don't want to commit more than 2% of our total assets, then our assets must be $25MM total.
Certainly this can be modified by many factors like are you a risk taker or not. Maybe then 2% isn't the right number but maybe 4 or 5% or maybe more. It definitely bears some thought into what kind of person you really are, and the comfort level you need with respect to your assets.
I think also that you need to be able to let go of that money. You need to be able to say that you will be OK if you never see that money again and just move on. If you cannot let go of the cash emotionally and intellectually, you'll be in a really poor mental state when your investments aren't doing well. Remember, that even if you employ the diversified/statistical method of investing, something like 6 of those companies will fail completely. I would not recommend you get into venture or angel investing if you're going to collapse mentally every time one of your portfolio companies dies. You'll go nuts and probably drive everyone else nuts around you. Because it WILL HAPPEN and you need to be able to deal with it.
You also need to have a healthy attitude towards money. Some people just can't. They assign way too much importance to cash in their lives. They can't let go of it, and they may do a Dr. Jekyll/Mr. Hyde thing on you. I've already experienced this once already in my life, and I have heard stories about many more. Friends, family all turning from loving people to the nightmares of your life. They will do things like hate you for losing their money, and never let you forget it. They will lie, cheat, steal - literally money does bring out the worst in people. Are you a closet Dr. Jekyll/Mr. Hyde with respect to money? If you are or even think you are, stay away from startup investing!
What's Your Real Motivation?
I am big on getting real insight into why I do anything. I want to really understand my motivations and feelings on it. So I think it is worthwhile asking yourself why you REALLY want to do this. If after all your inward analysis you still want to do this, then by all means go for it assuming the other stuff we talked about applies positively to you.
One big thing is to not delude oneself about the glamorous life of a startup investor. It ain't glamorous all the time and it takes a lot of work to do it well. And as much as you may say you want to build great companies, you won't be able to ignore the monetary aspect of it and how you're going to get your money out of the deal. Sometimes the two don't sync up exactly and you need to be ready to make a decision contrary to what you really want. You need to prepare yourself on the realities of what is going on here. Can you take your blinders off and really see what it takes realistically?
The Last Word
The last thing I'll say about whether you can be successful at this is: Are you a lucky person? By fate, or by creating your own luck (which I am big into - creating opportunities rather than just sitting back and hoping it will happen), I think luck plays a bigger role than people think. It is that slight edge you get by the will of the gods that will enable your video company to succeed, whereas the other 99 will not...
Really the Last Word
Don't create the 100th video company when there are 99 out there. But if your video company makes it big; then I would say you are lucky. Go invest more and call me to bring me into your next deal (haha).