If your startup isn’t suitable for VC investment, it’s not suitable for angels either
There’s a prevalent myth that while venture capitalists will only invest in startups with the potential for 100x returns, angel investors are happy with lower returns and invest in a wider range of startups. This is nonsense.
As an early-stage startup mentor, many of the startups I see preparing to pitch for investment are projecting revenues after 5 years at a realistic $10M or $20M.
Too often it falls to me to burst their bubble. Venture capitalists don’t invest in startups that can’t grow exponentially to $100M within 5 years, I have to tell them. Sorry.
The most common reaction is, “Oh, I’ll just update the revenue projections on our pitch deck to $100M!”
The more honest ones tell me, “That doesn’t matter because we’ll get funding from angel investors instead of VCs.”
The prevailing idea seems to be that venture capitalists are evil people who only invest in startups that can generate immoral levels of riches for themselves and their wealthy friends. Angel investors, by contrast, are munificent people who want nothing more than to help deserving founders get started.
I’ve been an angel investor for more than 15 years, invested individually in 50 startups and 100 more as an active member of two angel groups. While I like to think of myself as a good person, that’s just not how angel investing works. Angel investing is investing. We’re investing in startups to make money.
With a few critical exceptions I’ll get to below, angel investing is identical to venture capital but with smaller cheques. The economics that drive VCs to invest only in moonshots are the same for angel investors. Consequently, we invest in exactly the same kinds of exponential growth startups in sectors with oversized exits as VCs.
Venture Math for VCs and Angels
The rule of thumb for venture capital is that 9 out 10 startups will fail to provide a positive return to investors. That means that the one startup out of 10 that does succeed, needs to return 10x just to break even for the portfolio.
But nobody puts their money into risky investments locked up for 10 years just to break even. Over the 10 year life of a VC fund, to beat simpler, safer, more liquid investments in the S&P 500 or real estate, the fund will need to return 40x. Add in dilution over multiple rounds of investment and any startup that isn’t targeting at least a 100x exit isn’t worth investing in.
Angel investors have exactly the same economics, only worse. With smaller cheques, we have to invest at an earlier stage. That means 19 out of 20 investments will be duds. Just to break even, that one winner needs to return 20x.
Investing at an earlier stage a few years before the VCs, it usually takes 12–15 years for our successful investments to mature. If I want to get a return equivalent to the S&P 500 after waiting patiently for 15 years, I need that one winner to be huge.
Angel investing is investing. We could invest in the public stock market, or real estate, or artwork, or bitcoin. Angels invest in startups. Given the high risk and lack of liquidity, our investments need to have returns that beat the stock market. And that only happens if we invest in moonshots.
If a startup is valued at $10M when we invest, to get that 100x return, it needs to exit at $1B or more. In other words, we’re hunting for unicorns, the same as VCs.
However, there are three important exceptions where angels are willing to accept lower returns.
Exception #1: Supporters
Not all angels are investing for financial returns. Especially at the earliest stages, some will invest to support you or your mission.
I often invest in startups working on energy sustainability where solutions are critical for our continued existence on this planet. I’ll be thrilled just to break even on these investments. Consequently, the bar on my risk/reward is far lower than investments in software or consumer products.
It’s not always about saving the world. Sometimes, it’s about finding solutions you care about. I personally suffer from misophonia. If you have a promising treatment, I’m interested in investing. Diagnostics and treatments for thyroid cancer also hit close to home. For something personal, I’m not comparing the potential returns to that of my Apple and Nvidia stock.
These type of investments are more like friends & family than angel investing. It’s about supporting you and your solution rather than financial returns.
Many corporate investment funds take the same attitude —it’s not a donation, they don’t want to lose money, but the primary goal is to find and assist development of solutions to specific company challenges. A $5M investment in a startup is nothing for Exxon if it has the potential to save the company $100M in operating costs.
To find these investors, focus narrowly on your industry. Look for people who understand what you’re doing and why, and want to see you succeed. Pitch to retired executives in the sector. If you’re building AI for contracts, get lawyers to invest. If you have a better solution for network acceleration or traffic generation testing (my previous companies), I’m all ears.
Exception #2: Operators
The venture capital model (including angels) is similar to buying lottery tickets. We write a bunch of checks and hope that one hits big enough to more than make up for the losses. It’s a simple model that doesn’t take much work. But the low hit rate does require huge returns from the few successes.
Imagine instead investing in smaller but profitable businesses that reach $10M in revenues and generate $1M a year in profits. If I only had to put in a couple million to get started, that would be a fantastic investment.
There’s 2 problems, though. First, I’d need a success rate more like 90% instead of 10%. And second, I’d need a way to make sure management distributes that $1M as dividends to investors instead of paying themselves high salaries and holding company retreats in Bali.
Private equity has solved both problems by only investing in existing, successful businesses, and taking over the financial operations of the company to squeeze out every penny.
For startups, it’s much tougher. But for a solid business with a solid business plan that can reach profitability quickly, there are people who will join you as a partner, invest in the business and help run it. It might be a retired executive from the industry or it might be a financial whiz who knows how to manage businesses.
Operators are hard to find. They have to be deeply involved in the operations of the business, so can only invest in one or two companies at a time. Unlike VCs who encourage everyone to apply, operators are usually people in your network willing to join a startup on their journey.
Exception 3: Dumb money
There are many angel investors who don’t understand the economics of what they’re getting into. They aren’t dumb people, but because they don’t realize your startup has only a 1 in 10 chance of success at best, they make bad decisions. That was me for the first 5 years of angel investing.
Until you’ve seen enough good companies with brilliant founders and incredible products wither and die because the market was too small, because the husband and wife founding team got divorced, because Google released a free version, because the founder agreed to a 4x liquidation preference with later investors, or a million other reasons, every pitch sounds great.
When I first started investing in startups, every pitch sounded like a winner. Every pitch sounded like a way to make serious money. In hindsight, most had fatal flaws that I failed to see.
They weren’t bad companies or fraudulent founders (with a few exceptions), but for reasons that become obvious later, they were dumb investments.
During the Covid startup bubble, it seemed like everyone was either a startup founder or angel investor. Most of those supposed angels have lost enough money by now that they’re out of the game. The ones remaining have become more careful with their investments.
But there are still people out there who expect the success rate to be 90% instead of 10% and invest accordingly. They invest in startups that aren’t suitable for venture capital; they put money into SAFEs that will never get converted into stock; they invest in sectors VCs shun due to lack of exit potential. They won’t be hunting for unicorns and can be satisfied with the potential for a 2x return. They’re smart people making uninformed investment decisions. And sometimes those investments pay off big anyway, so who’s to say.
As an early-stage founder you take whatever investment you can find. But if your startup is too small for VC investment, it’s too small for angel investment. You’d be far better off looking at alternatives to venture funding that are more suitable for building a sustainable, profit-based company.
SüprDüpr raised $1B in venture capital to develop a teleporter. Under pressure from their investors, the founder pushed the schedule to get to commercial operation as quick as possible. Now one of the scientists is missing. Is it murder, or just a bug in the software? Find out in my über-crazy, süpr-fun, Silicon Valley novel, To Kill a Unicorn.
Pitching Angels 