8 ways to Mitigate Risk as an Angel Investor

Research done 6 years ago determined there were 7 key ways an angel investor could mitigate risk when making a private equity investment in an early stage company.

See the original article: http://myvirtualangelworld.com/2008/08/05/mitigating-risk-for-private-investors/

Additional experience in working with investors since then that have made multiple investments, yet not lost their investment, reveals one more way to reduce the risk in these young private companies. Number 8 method is to ensure the company has a clear strategy for generating revenue sufficient to sustain growth and profitability.. Market Validation, #7, is key because you know at least some customers want to buy the product or service, but only actually becoming profitable can lead to the kind of company that will produce a liquidity event that will provide a return on the investment. The company must understand how the will get their first customers, then expand their sales force or sales strategy to grow their pipeline, while also anticipating what they will need within their operations to support that sales growth.

Listen to the original podcast that has multiple guests explain each area that an investor can mitigate risk:
On ITunes (episode 153) https://itunes.apple.com/us/podcast/karen-rands-compassionate/id302182696?mt=2&ign-mpt=uo%3D4
Or download BeyondPod for Android or IPhone and subscribe to the Compassionate Capitalist show and listen to this episode and any others.

This particular show is longer than the others because of the rich content. The first 7 ways for mitigating risk are:
1.Intellectual Property Protection – patents, copyrights, trademark, trade secrets
2.Management Team/Advisers – experienced management from within or recruited from outside
3.Insurance – key man insurance, errors & omissions, other corporate insurance
4.Strategic Planning – what will they exactly do once they have their funds
5.Sales Validation – do they have the sales team/strategy that can achieve the expected results
6.Terms of Investment – small terms may have big impact on the angel investor down the road
7.Market Validation / Competition – having sold something or having market validation in a pipeline, joint venture, or in improving on the competition go a long way to validating the opportunity

This information is offered as part of an ongoing effort to educate High Net Worth men and women with a desire to become angel investors and are new to angel investing on how to diversify their portfolio to include private equity investments and increase their odds to produce a return on investment.   This is being delivered through the National Network of Angel Investors.   This particular topic will be a new chapter in the soon to be released revised edition of “Inside Secrets to Angel Investing”.   Visit the NNOAI website or the AngelInvesting101.com site to sign up for free excerpts from the Inside Secrets to Angel Investing.

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And on Facebook:   https://www.facebook.com/thenationalangelinvestornetwork

How to Create Wealth through Angel Investing

Angels are the financial fuel of the economy. Before Venture Capitalists get involved, before banks will loan a company an unsecured note; Angel Investors provide the capital that fuels the entrepreneurial spirit and helps inventions become products and ideas become reality.  They take the greatest risk, but also have the potential to reap the greatest rewards.   The return on investment for an affluent person who invests in a company at the early stage can be as much as 10 or 20 x.   The original investors in Microsoft, Amazon, Google, and even traditional non-tech businesses like Home Depot all made huge returns.  The logic behind it is quite fundamental….buy low, sell high.  But unlike buying a public stock at say $1 a share and it going to $20 a share are rare.   When an investor buys a private company’s stock at an early stage of their development, the likelihood of that stock increasing to reflect the growth in value from a start up to a revenue producing profitable company is much more likely to go from $1 privately to $20 as a public offering.

I like to refer to Angel Investors as Compassionate Capitalists. “Compassionate” because they have figured out that even though they can lose all their money, by providing investment capital to an entrepreneur with passion and purpose to see his or her company succeed, they are providing a hand up, not a hand out, that will fuel the economy by creating jobs and potentially whole markets by bringing innovation to the market. “Capitalists” because they aren’t donating to a charity, they are investing in a risky venture that banks won’t loan to and venture capitalist won’t even look at, with the intent of creating a big return on their investment. High net worth men and women become angel investors to create great wealth, never with the intent to lose money.

Angels are wealthy individuals who provide seed capital and growth capital to companies in the start up and early stage of their company’s life cycle. Their capital can be offered in exchange for equity in the company or as some specialized form of debt facility. Investing in this stage of company is the most risky, but it can also be the most rewarding. Rewards come not just from the financial returns, but also from experiencing the purest form of capitalism…bringing value to the market by supplying a product or service to satisfy a market demand. There is a definite sense of pride and accomplishment from being able to say you were an early investor in a block buster like Microsoft or Starbucks, and surprisingly, there is little regret from the early stage investors in the near misses like WebVAN and PETS.com because they got their sizable returns when those companies went public. It was the investors that followed the advice of their stock broker or financial planner to invest when those companies went public that saw a decline in the value of their investment because they bought at “retail” hoping that the value would increase over time. Angel investors buy stock when the company is still private, and reap their rewards when the company then sells that stock to another buyer or to the public stock market. They learned early in life that profit is made when buying at wholesale and selling at retail. That is how it works for the wise angel investor.

Investing or buying Private Equity of early stage companies is one of the secrets the wealthy use to create more wealth. As Robert Kiyosaki wrote in his best seller book, Rich Dad’s Retire Young, Retire Rich on page 127:

“the rich invest in shares of a company when the company is still a private company”.

To become a successful angel investor, it is important that individuals learn how to identify and screen opportunities for early stage private equity investing. In the eBook Series “How to Be an Angel Investor”, investors are taught how to take what they know from investing in public stocks and real estate and apply to making investment decisions about private equity investments.  You can subscribe to free excerpts of those books by going to this web page:  How To Be an Angel Investor

A survey of active angel investors revealed a startling and little known fact.   Most angel investors learn how to be angel investors by losing their investments….learn by doing and losing!  Oops won’t do that again. Investors can take classes on real estate investment and stock market investment, but rarely is there a class on angel investment.  Some new investors are fortunate if they have a mentor that will lead the way or if they are near an angel group that they can join to provide an environment to identify, vet, and co-invest with.  Many more potential investors are not located in an area where there is an angel investor group or they don’t want to be tied down to the commitments of a group.   The Center for Venture Research of New Hampshire University found in their survey of angel groups, 66% of the angel investors that could invest, didn’t.   They were called “latent” investors.  Here they are, part of an angel group, with full intentions of making investments into early stage and start up companies, but don’t actually stroke the check.  Why? It doesn’t make any sense until you learn that they hesitate because they are unfamiliar with the process.  Buying a public stock is easy….just call your broker, or go online and point and click.  Buying private stock involves signing paperwork; not really sure what you actually bought; how to measure the growth in value; when do you get to sell; do you get a piece of paper like a stock certificate for your $30,000???? and so on.   Even though broker/dealers are the ones authorized to sell private stock, most don’t because their costs to the companies are prohibitive for a pre-revenue company, and they discourage their wealthy clients from making those types of investments because of the fear of the SEC slapping them with a “selling away” charge and yanking their license.   What is a millionaire to do?

The ebook series described above was written for this very purpose.   Years of research, volumes of information, and scores of books were summarized for the consumption of a millionaire wanting to learn how to be an angel investor.

Can Angel Investors Make as Much as VC’s?

A recent article on the Fortune Small Business addressed this very topic: 

Angel investors operating in organized groups are seeing average returns on investment similar to those enjoyed by venture capitalists, according to a new study. 

The Article went on to say:

Kauffman Foundation and the Angel Capital Education Foundation, the “Returns of Angel Investors in Groups” study claims to be the largest of its kind. The study shows that organized angel investor groups in North America have seen average returns of as much as 2.6 times their initial investment over three and a half years from investment to exit. 

Therefore….

That’s an average internal rate of return (IRR) of 27%, similar to the average IRRs seen by private equity investors such as venture capitalists, who usually get involved in a business at a later stage of growth and are therefore commonly thought to take on less risk.

For the wealthy person, thinking about creating a greater yield from his or her portfolio, this is great news.  Yes there is great risk with angel investing, and it inherently it is unpredictable, but there are certain things that can be done to mitigate risk and you can set up criteria that helps you reduce the emotional element that causes some investors to invest when deep down they know they shouldn’t.

This also speaks to the value of having access to due diligence documents and access to groups of angels or other angels that can help mitigate risk, either because of their knowledge or just the collaboration that comes from multiple investors going in on an investment.