Reducing the Risk: Angel Investing
By: Ziad K. Abdelnour
As a renowned investor, I get a lot of questions about how to invest. One of the questions I get the most is “Which is better? IPO’s or investing into start-ups?” To be quite frank, it is like comparing apples and pears. Yes, they are similar, but success is measured very differently between the two.
Angel investing usually means putting money into startups, so you are getting in there before private equity and a long time before firms IPO on the stock market. Your taking on the task of spotting the potential in a company long before they prove themselves. While it’s not a simple task, if you pick the companies you invest in wisely, it can be very lucrative. Take Facebook for instance, a lot of people would say that Facebook did better when it was small versus now that it is a mega stock and on the S&P 500. However, it’s needless to say, angel investing has so many risks and picking the right firm to invest in is a difficult job.
The fact is, you won’t make that much money from the majority of angel deals. It is definitely a high net worth game and you have to be willing to take a loss here or there. Even many of the best angel investors have lost money on a great amount of the deals they have engaged in. This is why the requirements are so high in many countries to be eligible to engage in angel investing in many countries.
With that being said, there are a few things that you can do to reduce the risk. Perhaps the most common way that angel investors reduce risk is by investing in tens of startups. The more companies you invest in the more likely it is that at least one of them will go on to be very successful. However, this is not the only way for angel investors to reduce risk. Here are some other things to consider:
- Keep in mind that angel investing is a long game. In many cases your investment is completely illiquid for years and you can’t get out for 7–10 years+, unlike publicly-traded stocks which can be sold instantly.
- Take the founder’s background into consideration. It’s not uncommon that many start-up founders have unrealistic expectations. This means that many of the best angel investors meet loads of founders and the ones that stick out are knowledgeable, experienced and passionate. Time is money, so angel investors can’t waste time dealing with startups who have unprepared founders and should be factored in.
- Ask yourself, what can you offer other than money? Plenty of founders aren’t just looking for money, even though some are. Others are looking for contacts and expertise, alongside money. This can be a hassle for some investors and if so, angel investing probably isn’t right for you.
- Consider hiring lawyers for obvious reasons. You saw with Facebook’s early lawsuits that many people feel wronged by these kinds of things. In comparison, ETFs and stocks are more transparent. Less things can go wrong.
- Location is important when it comes to angel investing. Investing in a start can be very demanding and requires that you be in close proximity to assist with some of the issues the startup will face. While it is possible to do things remotely with angel investing, it is much harder compared to normal stock market investing. It can also complicate taxes. Also, if you invest in firms outside your jurisdiction, it is even riskier. For publicly-traded stocks it doesn’t matter as much. For instance, if you are an American who buys the FTSE All Stars, you aren’t really taking any more risk than a British person, apart from currency. Same with a British person who wants to buy the S&P 500 or indeed Amazon’s stock. Private investments are different.
So, yes, angel investing can return more than the general stock market and be very lucrative if done correctly. It just takes more time, tolerance for risk and patience to see the deals monetize. Investing is all about taking chances and strategically picking the best horse in the race. There is risk in any deals that you make not matter in your angel investing or buying stocks. Therefore, when people ask which is best, angel investing or IPO’s. It simply comes down to your goals and preferences.