I try to look at angel investing through the lens of behavioral economics. The future of an early stage company is highly uncertain, and on top of that, every potential investor is afflicted with incomplete information. Therefore, the investment decisions entail a mix of logical analysis, instinct and emotion.
This means angel investing is hard. Let’s examine all the ways we can screw it up.
PICKING THE WRONG HORSE
FOMO - I pride myself on having a measured process for decision making. But sometimes I’ve thrown that out the window because there were one or two signals that I latched on to under time pressure. Out of my 25 direct deals so far, 3 failed. While this is not a bad percentage, it turns out that for 2 of the 3, I made a snap decision within 48 hours of first meeting because there was an investor I admire backing the round, and the round was nearly full and closing shortly. I didn’t have special insight into the lead investors’ portfolio strategy or reasons for investing, or even a chance to speak with them. Nobody is totally immune to being swept up in the moment.
FINDING A SECRET - In one of the 2 failure cases above, I was going to be the only angel with a small check on the cap table. So I was also able to convince myself to move quickly by thinking that I had found some kind of special opportunity due to my rapport with the founder. This was absurd because the company had presented at an accelerator demo day a month earlier. I should have been asking myself why there weren’t more investors in the round instead.
FALLING IN LOVE WITH AN IDEA/MARKET - I have a few companies in my portfolio that are just treading water now, with a service I believed “had to exist” due my beliefs about customer demand, or chasing a market that I was super excited about without much competition. But I didn’t stop to convince myself that they had the right service and team to execute. First-mover advantage is not a guarantee of success.
MISSING A WINNER
ANALYSIS PARALYSIS - There’s a balance point between moving too fast and moving too slow. Especially when you’re a small check. I’ve over-diligenced a few deals, thinking I had time because the founders weren’t planning on closing imminently or hadn’t filled much of the round yet. But when I eventually decided to invest, they refused because they’d found an investor to take the rest of the round. A few of these have gone on to big Series A markups from marquee VC firms.
COMPETITION - I’ve passed on some good deals because it was so obvious to me at the time that one of the tech giants (FB, Google, Amazon, etc.) could kill the startup by competing. It’s important to ask, why haven’t they competed yet, and what are some strategic downsides for them to enter the market, or operational challenges that would provide the smaller startup with an advantage. In all of these cases, I’ve come to understand later that this wasn’t a significant risk. On the other hand, if there are lots of early-stage startups competing and they have backers with deep pockets, that is probably a bigger concern. Not a dispositive one, though, because sometimes it just means the market they’re going after is really worth the effort to compete.
CLUSTERS - Good deals are not evenly distributed over time. They can come in waves. It can be hard to avoid the impulse to stack rank the current opportunities and pass on a few so that capital outflows are smoother, because that just feels more prudent. This can be just as much of a mistake as it would be to make an investment in a mediocre opportunity after a long period of not seeing anything promising.
FAILING TO CHASE WINNERS
It can be tempting to dip into funds set aside for follow-on rounds in order to fund shiny new investments in earlier stage startups. I’ve done it myself. Putting money in a follow-on round can feel boring compared to getting to know a new team.
CHARITY
Sometimes I see a startup aiming to change the world in a very positive way (e.g. fighting climate change), and I want to help them because I want to see that change in the world. The thing is, if they can’t actually build a profitable business, then it might actually be more efficient to donate to a charitable foundation. I try to examine the emotional motivations behind my convictions.
DUMB MONEY
I’ll have better returns in the long run by investing in startups where I can add value after the investment. It increases the odds of success and it’s rare to find a book about startup investing that doesn’t mention this principle. But that doesn’t mean it’s easy to do. At times I’ve quickly convinced myself and the founders that I can help them based on my background or network, only to find out later that my impact is limited despite best intentions. And in the worst case, I might end up just being a nuisance.
There’s a flip side to this, though - I want to find teams that don’t need too much help from their investors. Because this might be a signal that they aren’t able to hire the employees they need to win.
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