OVER the past 40 years, startups have benefited from steadily declining interest rates. As the ecosystem flourished, South-east Asia saw 19 startups achieve unicorn status in 2021, and angel investing emerged as a compelling investment option.
After all, who wouldn’t be excited about a chance to be an early investor of the next Airbnb or Grab?
But aggressive rate hikes by global central banks last year changed the landscape. With interest rates staying up and concerns over weak growth growing louder, investors are now understandably cautious about the risks of startup failure that’s inherent in angel investing.
How can we predict which startup will fail and which will ultimately succeed?
The risks and allure of angel investing
One of the biggest draws of angel investing is the opportunity for lucrative returns. As more companies wait longer to go public, significant growth and value creation often happen in the years before IPO. By injecting capital in the early stages of a startup, investors stand a chance to multiply their investment significantly.
Ryan Reynolds – yes, the Hollywood star and Marvel superhero – has an impressive portfolio that demonstrates the possibilities of private market investing.
A NEWSLETTER FOR YOU
Garage
The hottest news on all things startup and tech to kickstart your week.
Although Reynolds only started out in 2018, his portfolio has already yielded two unicorns – Wealthsimple and 1Password. In 2019, Reynolds also acquired a stake in Mint Mobile, a wireless mobile carrier, which was purchased by a major US telco for an estimated US$1.35 billion earlier this year.
However, angel investing is much riskier than investing in public markets. Angel investing usually occurs at the earliest stages of a company, sometimes when the product is still only an idea. And with the global economy still shrouded in uncertainty, predicting the fate of startups is a formidable task for most investors.
Why diversification is your superpower
Ryan Reynolds has a superpower: A unique combination of financial resources, personal brand, story-telling ability, and most of all, an extensive network. It’s a composite that is impossible to replicate for most of us.
The good news is that you don’t need to be a Marvel superhero to be a successful angel investor. However, if you’re investing in early-stage companies for the potential size of returns, you need to adopt a strategic approach that does not rely on stardom to generate viral ads.
That’s why diversification is key. Diversification is one of the most effective ways to mitigate the inherent risk in startup investing. Investing in a single startup is like putting all your eggs in one basket and balancing that basket on top of a 10-foot pole. If that startup fails, all your invested capital is lost. However, by spreading your capital across multiple startups, you minimise the impact of any single failure.
Research shows that the more early-stage companies you invest in, the better your odds of a successful outcome. Irving Ebert, from the Ottawa Angels, conducted impressive Monte Carlo simulations using data from the US and UK, and discovered that by expanding a portfolio to around 50 investments, the overall return tends to approximate the top 5 per cent of all possible outcomes.
That said, the minimum investment amount required for angel investments is usually around US$20,000-US$50,000 per deal. This makes building a diversified portfolio of at least 20 companies difficult (unless you have a net worth of US$20 million to US$30 million).
Still, there are other ways to get your foot into the world of startup investing while mitigating potential risks.
Tapping a strong angel network
It’s also not just about quantity. The key to angel investing also lies in picking top-quality startups – a process that requires rigorous due diligence, a keen understanding of the potential market, the ability to evaluate business models, startup teams, product viability, and often, a bit of luck.
Angel networks bring together individuals with diverse backgrounds and areas of expertise. They come together to gather valuable information on startups that their members invest in and can provide support and mentoring to their portfolio companies. Networks often have a formal process for evaluating potential investments, including financial analysis, market research, and vetting of the startup’s team. This shared workload can lead to better investment decisions.
As startups are attracted to the potential for larger investment amounts and mentoring opportunities, angel networks often see a higher volume and quality of deal flow than an individual investor would.
It’s easy to get swept up in gloomy headlines, but let’s not overlook how exciting technological breakthroughs have continued to emerge. Generative AI, for example, is expected to add up to US$4.4 trillion annually to the global economy – that’s more than the United Kingdom’s entire GDP in 2021.
The writer is head of reserve at StashAway
Keyword added to your list