Improving the essentials: How we started to build a strategy as angel investor
How we started to do angel investments
Most angels are extremely passionate and positively opportunistic. No wonder, as most of them are entrepreneurs themselves. New opportunities excite us and get us thinking how bright the future could be.
Being (overly) optimistic is definitely one of the core characteristic of most entrepreneurs, after all.
However, this mix is not necessarily the best for startup investors.
We fell into this trap as well. Luckily, without taking too much harm. But we definitely also invested in cases that made little sense from an investor standpoint of view, but in hindsight were more like a passionate support for exciting founders.
This does not mean they were all fails, though!
For example, we invested into Pottsalat - a salad delivery service for the Western German regions. Their truly eco-friendly and health-based concept was hitting the Zeitgeist and the founding team was (and still is) incredibly passionate and driven. Checkmark!
However, re-thinking the case, it appears pretty clear that this is not the typical VC case (which it doesn’t need to be anyway). Scalability is difficult, very capital intensive (involving investment in hardware, operations and direct-to-consumer marketing), while achieving naturally limited financial returns.
Pottsalat managed to navigate the landscape successfully, continued to raise money via crowdfunding, and expanded tremendously. Lucky for us, a well-fitting strategic investor decided to come on board and bought our shares in a secondary.
Great story! But not very strategic.
This will be a series of post on our investment strategy, our tools and processes.
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Improving it all: Building the foundation of a strategy for angels
By continuously challenging ourselves, we started to collect learnings about our preferences and also about how we can generate some returns - (kind of our credo: having fun, while also earning money with it).
The foundation of our strategy consists of three pillars:
The target portfolio
The selection process
and the deal flow itself
Plan a portfolio that is able to generate returns
This might be counterintuitive - of course every angel wants to generate returns.
However, most portfolio configurations actually are doomed from the beginning.
The keyword for us is risk/return multiples.
Understanding risk and return
A lot of startups fail. VCs know this and go for unicorn hunting to make their portfolio economics work. Simply put: If 80% of your startups fail, the remaining 20% must recover all fails AND pay you a premium to generate return.
For example, suppose an angel investor builds a startup portfolio with a volume of €1 million. She invests initial ticket sizes of €100,000, with no follow-on’s. In that case, she would end up with 10 companies in her portfolio. Assuming an 80% failure rate, she would need to recover her total investment of €1M from two companies, plus the outstanding return.
If both remaining companies generate a 3x return (aka €300.000 each), the portfolio accumulates - €400.000 after all.
Read more about calculating exit benchmarks for startups in our article here.
Don’t get fooled by overconfidence. At JVH Ventures, we face a 64% failure rate for our historic investments. Mostly, this rate lies between 60-80% for most early-stage investors. So assuming these rates definitely makes sense for most angels.
Therefore, it’s extremely important to reach a portfolio size that is large enough to account for this risk of failure. In light of returns, the smaller the portfolio, the higher the expectations for each startup.
Interested to use our Risk/Return Calculator for your next investment opportunity?
Join our AngelCrew Community!
Focus on stages and verticals
In addition, we found it also helpful to clarify our focus on stages and verticals.
Stages are kind of naturally limited for angels, but adhering to this rule is sometimes difficult, if excitement strikes.
Focussing on a number of verticals and areas of expertise is also often overlooked for angels. However, in the medium- to long-run there are three main positive effects:
Better deal judgement
Branding effects which lead to better deal flow
Higher benefit for the founders to profit from your expertise
💡💡💡 While our strategy builds somewhat organically, we are currently only going for potential high return cases (e.g. 50x) in early-stage settings (1st or 2nd round). We focus on everything related to software, but did not limit our scope too much, except to consumer apps, hardware, and partly the web3 space.
It’s a numbers game - so be patient!
Let’s assume you just started angel investing. You looked deeper at your first 10 opportunities and had calls with the all-impressive founders. How many investments will you end up with pursuing? Even if you just went with two of them, the numbers will not match up.
Here is why:
Let’s extend the thought and assume you talked to a hundred founders.
Naturally, your criteria will evolve and you will most likely not end up with 20 investments (2 of 10), but probably with just 2-5 actual investments. Your experience grows, you will build a form of pattern recognition and naturally you will get more picky to distinguish good from great, and great from exceptional.
So with your growing experience, there will be zero overlap between the first two selected opportunities (after looking into 10 deals) and the later 2-5 investments (after looking into 100 deals) if you look at the deal sets retro-perspectively.
The same will hold true for the next 1000 deals, and so on.
Especially, developing investment criteria and a process will help to compare deals over time. Scoring deals for example will also help you to see how your ratings develop over time on average. Exchanging or adding criteria will also guide your decision-making process to be more selective.
💡💡💡 While your first deal opportunities will seem very exciting, it’s not wise to jump right in. Be patient and continue to build a pattern recognition. It will come over time. Otherwise, you will end up funding deals that your future-self would pass right on.
Read more on our investment process and criteria in our article here.
Generate higher quality deal flow!
Next to SELECTING higher quality deals, the next lever is to GENERATE more of them as well.
While for many angels deal flow is inbound and passive, there are still several things you can actively improve here.
There are multiple ways of doing this. We went with building and leveraging a network of investors on our own, but there are also different clubs and networks you can join.
But be careful, as joining a sub-par network will naturally generate rather sub-par deals, because of signalling and adverse selection, as great startups will try to avoid investors (and networks) with less signalling power.
What worked well for us is to exchange deals with others, especially with people we would like to work with and that have strong deal flow in areas of interest for us. This might take longer, but again: Be patient! Time will bring good results.
💡💡💡 Feel free to pre-register for our Angel Crew, where we share our weekly deal flow with our closer network!