Angel Investing: The Gust Guide to Making Money and Having Fun Investing in Startups

A Conversation with David S. Rose,

Author of ANGEL INVESTING

1.      What prompted you to write ANGEL INVESTING?

As a third generation angel investor who has helped to fund over 90 innovative companies—several of which have gone from a gleam in the eye of an entrepreneur to being worth hundreds of millions of dollars—I have seen first hand how profitable and fun this asset class can be for an investor. Yet most people who call themselves “angel investors” actually lose money! This book for the first time provides a complete, detailed guide to professional angel investing, and shows that well thought out angel investments can be a significant addition to an alternative assets portfolio.

 2.      Who is the audience for this book?

There are three different audiences: the first is the seven million people in the US (and many millions more internationally) who qualify as Accredited Investors because they have either an annual income of over $200,000 or net assets of over $1 million—they can invest today in startups as much as they want with no restrictions. The second audience is the 40 million ‘mass affluent’, with incomes over $75,000 or net assets over $100,000. They are the investors for whom the JOBS Act of 2012 was designed, and as soon as the SEC issues regulations this year, they will be able to invest in startups through new Equity Crowdfunding platforms. The third audience consists of all the high-growth entrepreneurs who are seeking (or considering seeking) funding from angels, and want to understand how angels think and what they are looking for in the companies in which they invest.

 3.      What is it about now that has transformed angel investing from a random alternative investment option to a serious and legitimate discipline?

The explosive advancements in technology over the past few decades have fundamentally changed the nature of startups. My own first startup venture in the early 1990s required $20 million in venture capital funding before we were able to ship our Internet-based product. My second venture—just a few years later—took only $2 million in venture funding to get to Internet product shipment. When I began angel investing, the first company I funded required only $200,000 to ship their product. A few years ago, New York Angels invested in a company that had been seeded with only $20,000 and that was already generating significant revenue when we invested. What this means is that much less money is required to start a company, which means that many more people are able to participate with lower investment amounts. And with more people investing, the ones who do it intelligently and professionally are the ones who are going to make money.

 4.      What are the new trends we are seeing in angel investing today that didn’t happen ten years ago?

Because of rapidly dropping costs of starting a company, there are many more companies being started. And because of the emergence of Internet-based platforms like Gust, it is now possible for independent angel investors to easily get access to a wide variety of investment opportunities, and then explore, collaborate and manage those investments in a way that will optimize the overall value of their portfolios.

 5.      Which angel investing practices are most in need of guidance?

Historically, most “angel investments” were emotional ones, or done by happenstance, or as a favor to a friend. And that’s why most so-called angels lost money. But as professional angel groups and investors have emerged over the past decade, best practices have evolved, along with the accessibility and tools for professionalized angel investing. So instead of throwing money at semi-random deals, smart angels develop a long term strategy to which they commit a set amount of capital, and then invest according to the strategy. The result is that over the long run, 25% annual returns are a very realistic target for serious, professional angels.

 6.      What tips do you have for entrepreneurs on how to gain access to angel investors and their funding?

Network! While there really is not such a thing as the “old boy network”, it is very true that most angel investments come from referrals where someone introduces the entrepreneur to the angel (or angel group). As a result, entrepreneurs should actively make use of their social networks (such as LinkedIn), and in-person networks (such as Meetups) to find their way to people who can introduce them to angels. When last I looked, there were over 15 million people who could reach me through an introduction from a first, second or third degree connection on LinkedIn!

 7.      In the book, you recommend that every angel investor should invest in at least 20 companies. Why do you recommend this approach?

Because of The Law of Large Numbers. Most startups fail. That’s a fact. And no matter how sexy an investment looks, experience has shown that it likely has as much of a chance of failing as a not-so-sexy one. But, when a company succeeds, the kinds of ventures in which angels invest have the potential to pay off in very large multiples: 10, 20, 30, even 50 times the original investment! So in order to have the best chance that your portfolio will have at least one or two of these “home runs”, it’s important that you invest in enough companies to tilt the odds in your favor. Experience (and mathematics) shows that a 20 company portfolio is about the minimum size to make the numbers work, with more being even better.

 8.      Why is now the right time to consider angel investing vs. other types of investments?

Because rates of return from traditional investment options are shrinking (banks pay less than 1%, the stock market might return 4-5%, even hedge funds have trouble regularly returning more than 10-15%. But with the future of business increasingly being defined by high-growth startups, there are more possibilities than ever to ride along with angel investments for enormous growth. This is still a very high-risk, high-reward asset class, but for those with the resources and interest to invest, it’s a very smart component for the ‘alternative asset’ part of your portfolio.

 9.      What are some quantitative metrics angel investors look for in a pitch?

Unfortunately there’s nothing that can be generalized, because each case is different. Realistically, most angel deals are very early stage, which means that reliable metrics are pretty hard to come by. So most of the number crunching and ‘what if’ analyses tend to focus on customer adoption rates (are people actually using the product in ever increasing numbers), revenues (are you making money from those customers), and churn rates (are your customers coming back from more once you’ve got them to try the product). Angels seek to balance the potential upside of an investment with the least amount of risk. For a startup, that risk-mitigation usually comes down to ‘traction’ and ‘product/market fit’.

 10.  What does it feel like to invest in a failed startup as an angel investor?

The first time, it’s traumatic. The second time, it hurts. After that, it’s disappointing. Professional angels know that fully half of their investments are going to fail completely, but that the overall portfolio will be profitable because of the ones that hit big. If someone isn’t mentally or emotionally prepared for those facts of life, they shouldn’t become an angel investor.

 11.  What are the benefits – financial and non-financial – of becoming an angel investor?

Economically, a professionally managed, significantly sized angel portfolio is capable of generating returns of more than 25% annually…over the long term. That should be the primary motivation for becoming a professional angel. But the intangible rewards are often even greater. Being involved at the cutting edge of technology is fascinating and fun, being involved as a mentor for a bright young entrepreneur is heartwarming and emotionally rewarding, and co-investing with other smart angels is a great way to find new friends with similar mindsets.

 12.  What are three things entrepreneurs should look for in an angel investor?

Integrity, experience as an angel investor, and deep pockets for follow on rounds!

 Which investment is arguably your best-known investment? Are there any of your own memorable investment stories or outcomes that you would like to share?

I first saw Comixology when I was judging the NYU business plan competition many years ago, and then led their investment round for New York Angels. In the years since, they have become the dominant distribution hub for comic books, with hundreds of millions of downloads by passionate purchasers from around the world. Last week, the company announced that it was being acquired by Amazon. Other investments that I discuss in the book may be lesser known—even though they were acquired by companies like Facebook, Intel, Google and CBS—but nevertheless still returned 10, 20 or 30 times the original investment because the deals were structured and valued appropriately.

 From your perspective, what are the most important things that angel investors can do individually to help raise the perception of the ‘smart’ angel investor?

Smart angels try to reduce the emotional aspects of their investment, and focus on the overall process of angel investing as an on-going investment strategy. Instead of trumpeting either their luck at “hitting the big one”, or their “skill at only picking winners”, they should discuss their angel investing activities in the context of a rational, long-term strategy to add a high-risk, high-return component to their alternative asset investments. Let’s say, for example, that only 10% of your whole investment portfolio is devoted to angel investments, but that, over time, they generate a 25% IRR. Meanwhile, the return on the other, safer, 90% (a typically balanced portfolio of stocks, bonds and savings) averages 5%. The result is that even this relatively small allocation to startups would increase your portfolio’s overall return by 40%.

15.  Can you talk a little about the beginnings of Gust? What is the main mission of your organization and how has it grown—and in what ways—since its inception?

From its very beginnings, Gust has been dedicated to building the global platform for early stage finance, connecting high-growth startup companies with smart, active angel investors. Since it is always easier to find people who want money, compared to people who have money, we began with the harder side and built a platform dedicated to supporting angel investors in groups. As usage grew and the market expanded, we added support for startup companies, venture capital funds, incubators and other market participants. Today, Gust is used by over 250,000 startups, over 50,000 angel investors and over 1,000 investment organizations to find, connect and collaborate with each other.

 16.  How did you get into angel investing?

I’m actually a third generation angel investor, as well as being a third generation entrepreneur! My great uncle, the original David Rose (after whom I was named), was the angel investor behind the portable artificial kidney, vascular stapling technology, hyperbaric operating rooms, desalination systems and through the wall air conditioning.

 17.  How does the New York City investing scene differ from that of Silicon Valley?

Silicon Valley has been the center of technology startups since the early days of computers and the venture capitalists who invested in them. On the other hand, New York has been the center of business for over a century, but with little technology development. The rise of the Internet, and its applicability to all businesses, means that the startup scene in New York is now exploding, making it the center of so-called “hyphen tech”. That is, financial-technology, advertising-technology, fashion-technology, and so forth. When it comes to early stage investing, West Coast angels tend to ‘swing for the fences’ and concentrate only on the big hit winners, whereas East Coast angels tend to look at long-term of their whole portfolio.

 18.  What factors are important when deciding to invest in a young company?

First and most important is the team. We call it “betting the jockey, not the horse”. Because companies and business plans always change, investors will virtually always choose to finance an A+ entrepreneur and his or her team, rather than a good idea with mediocre management. After that, we look for things like a large and growing market, a scalable business model, a competitive advantage and a rational opportunity to make a significant return on our investment. But even those factors are not enough, because we also look at the the entrepreneur has done with the company so far. Has she achieved “product/market fit”? Developed traction from customers? Taken at least some of the risk out of equation? All of these are looked at holistically when we’re trying to decide on what investments to make.

 19.  Do you think all the talk about another tech bubble is true?  Should angel investors be concerned?

Absolutely not. The pace of technological change is increasing every year, which means that there are always enormous opportunities for new businesses with new solutions to enter—and often dominate—new and old markets alike. Just because one or two companies have high-profile exits in the billions of dollars, or because a few highly-publicized deals in Silicon Valley are being made at high valuations, it doesn’t mean that the rest of the world is in trouble. This is a great time to become an angel!

 20. How can a founder tell if they are dealing with a serious angel investor?

Do the same reference checks on your angels that they would do on you! Check out their portfolios, ask to speak to the CEOs of other companies in which they have invested, look at their references on LinkedIn, read their blog posts and do your homework. Serious angels will generally give a founder a quick, firm answer; will never, ever charge fees of any kind; will use industry-standard deal structures and documentation; and will be generous with feedback and introductions to their networks.