You Don’t Need to be Rich and Famous to Be an Angel Investor – But You do Need to Ask One Critical Question

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When Casper, the New York-based mattress startup, decided to raise money, it didn’t just talk to VC firms. Instead, it put together a consortium that included angel investors like Ashton Kutcher, Leonardo DiCaprio, Tobey Maguire, and Maroon 5 frontman Adam Levine. Maybe it’s time for Neiman Marcus to start stocking hoodies at its Beverly Hills store.

It’s no surprise that that so many celebrities are flocking to invest in startups. Kutcher, a prolific angel, knows that one well-placed investment in a startup could make those royalty checks from Two and Half Men seem paltry in comparison.

The good news is that you don’t need to be rich and famous to become an angel investor.  According to the Center for Venture Research at the University of New Hampshire, in 2014 more than 300,000 angel investors across the United States funded in excess of $24 billion in entrepreneurial ventures. Often, companies allow investors to put as little as $5,000 or $10,000 into a deal. Before you reach for your checkbook, however, keep in mind that when it comes to angel investing, the odds are stacked against you. According to a study by Prof. Shikhar Ghosh at Harvard Business School, some 75% of startups do not deliver promised returns to investors.

If you’re going to consider making an early stage investment, you must approach the decision with rigor. Otherwise, it can be tempting to invest in projects for the wrong reasons, including personal relationships, boredom at the office, or a desire to be part of a company that plays to your ego rather than your bank account.

So how do you make smart investments? Over the course of my career, I’ve invested in more than twenty businesses and analyzed hundreds more, ranging from Silicon Valley–based startups to larger, more established firms operating in the United States, Latin America, and Asia. Over time, I’ve learned that no matter where a company is located, what it does, or where it is in its growth cycle, deciding whether not to invest comes down to 3 basic due diligence questions, the first two of which won’t be too surprising if you’ve looked at investments in the past:

  1. Is the business attractive? Is it positioned for success, and does it operate in an attractive industry?
  2. Are your partners, from the investors to the managers, competent and ethical? Are they the right people for the job?
  3. There is a third, additional point, however, that’s not so standard, and this is the one that has saved me countless times over the course of my career. Can you contribute to the success of the company in order to personally increase the value of your investment?

Put simply, if you cannot provide meaningful insights or make an introduction to a client, key hire, or investor, then you don’t know the company, the industry, or the team well enough to bet on it. In that case, you’re nothing more than a source of cash.  

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This third point is driven by self-interest.  If you can’t help the team, how sure can you be that they will return your calls and look out for your best interests? Founders are busy people and they can be surprisingly flaky.  Once you send in your check, you may never hear from a company again until it’s either sold or liquidated. When you’re Ashton Kutcher or Tobey McGuire, you’re pretty much assured that founders will keep you in the loop – and you can send your manger to camp out at their office if they don’t.  For the rest of us, being an active investor who actually does something will keep you engaged and informed.  It will also position you to invest in future endeavors with the same group of people.

As an angel investor, your dream scenario is to fund a group of talented entrepreneurs who you can back in every project they take on over the course of their careers.  In that way, you’ll benefit from the experience they gain with each new venture, increasing the odds of a big payout along the way.  So even if an investment looks like a no-brainer from the outset, you owe it to yourself – and your bank account – to make your investment decision based on fundamentals and to find a way to make an impact.  Let’s hope that Hollywood is doing the same.  

1 Comment

  1. Patrick,

    Greta article. Yes, the third question i key. I have been an entrepreneur for 17 years and most of the investors do not cut it. As Vinod Khosla once said, 70% of VC’s do not bring any value, in fact 20% bring negative value, orly 10% bring added value.

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