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Guide to Angel Investing

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I had the chance to attend the 1st in-person YC Startup Investor School back in March.

All content here:

https://investor.startupschool.org

Really useful data driven investing fundamentals.

The networking connections and opportunities have been invaluable.

Thanks to YC and all who attended.

I watched all of these lectures online. It's truly insightful!

I'm too poor to be angel investor but I do like to listen angel investors and venture capitalists because they can give me insights about how to find brilliant ideas and what's common signs of prospective ideas.

I think advices from ex-entrepreneurs who turned into angel investors or venture capitalists are much more valuable than from first or one time successful entrepreneurs because they know both sides. It's hard to impossible to distinguish talent from luck based on one time success. But if someone repeatedly find unicorns over the years, it's most probably talent and I would listen that person with great attention.

One of my key takeaways from these lectures - really good idea for startup often sounds like bad idea because if idea sounded obviously good it would be most probably already executed by some big corp.

This takeaway teach me not be overly dismissive of ideas which are not obviously good and be careful with ideas which sound obviously good.

P.S. I know that soft-skills (e.g. leadership) and team are very important for success but it's not insightful information.

Good post.

I’m constantly trying to learn both sides of the fence as a startup founder and angel investor.

I truly believe learning how to be a better angel investor also helps one be a better startup founder, and vice versa.

Two sides to the same coin.

One of my biggest takeaways from the in-person YC Startup Investor School is how truly important reputation is.

While I’ve always worked hard to develop a good reputation, it was reinforced just how incredibly important reputation and crystal clear communication is between founders and investors.

I appreciate someone formally writing out their thoughts.

My instinct and conventional advice reflects the principles outlined in this guide.

However, how do we know it’s true?

I know one entrepreneur who passed on the best deal of his life because there was no traction and the team seemed to be bad (he didn’t offer how he knew this.)

They had a great product but of course he discounted that.

It would be interesting to see what the data says.

Ultimately the one with the biggest pockets wins in that scenario.

A firm that has enough money to fund 300 businesses will probably have a lot less variance/cash flow problems than one that can only afford to fund 30.

The big fund won't pass on a murky deal because it can afford to be wrong.

Weirdly enough most of the folks with large funds (e.g. mid-sized VC firms) do not make a large number of bets because their MO is to take a board seat with an investment. Because there's an effective limit on the number of boards one can sit on and fulfill a fiduciary duty to each corporation, there are only so many checks the firm will write. They are further constrained by fund timing (having a few years at the start to deploy capital and generally ten years to return it). Worse yet, they need one big success that will return the fund in order to earn carry. So they have a fixed number of bets, one of which must make it really big in less than ten years. Needless to say with all of these constraints most VC funds fail to beat the public markets. Many VCs given these constraints follow the advice in this article and invest mainly in companies that already have good traction. The problem is that everyone wants to invest in these companies so those that get in either overpay or have some reason why they have gotten access to proprietary deal flow.

Angels that make small, passive investments can build very broad portfolios, wait patiently over long time horizons, and make money when even a single investment returns. Angels can afford to be wrong much more often and make much edgier bets. Nearly all seed funding these days is provided by angels.

Over a broad portfolio, that's where the returns are.

Background: started two companies, invested in 50+, advised 15+, run three funds/syndicates.

Sequoia, Andreessen, Bessemer, Greylock have hundreds of investments, not to mention the seed LP and scout programs. Yes, some of the really big growth stage funds make fewer, but larger investments but that’s a function of supply.

In a power law distribution or returns you need to make a large number of bets to be in the big winners because the median is often significantly less than the mean value.

Without arguing against the power law distribution (which is real and measured), the discussion here is more about vehicle. VCs usually have an LPA that positions the fund as "smart money" (justifying the management fee and carry) and therefore coupling investment with active company involvement which must by definition hinder the quantity of investments made.

The above mentioned funds are longstanding and extraordinarily successful series of funds - an individual fund typically doesn't make more than 30 or so investments. There are certainly seed funds / programs like 500, YC, and Right Side Capital that use different mechanisms (notably: passive investment) in order to deploy more bets. The approach was arguably pioneered by Ron Conway who was at the time derided for being "spray and pray" but was later found to have exceptional returns due to the efficacy of "black swan" investing - which is to say that pretty much all of the signals that one believes confidently are good markers of a successful startup are wrong in precisely the most important category-breakout cases. Consequently a humble investor desires to both invest in a large number of companies, realizes that their active involvement is likely to do as much harm as gain (witness returns on investor-controlled vs founder-controlled companies), and constantly questions their own assumptions with portfolio performance data.

But an overall model / LPA that forces you into a "smart money" model will keep you from operating in this way.

This is where the advantage of the angel investor comes in - to take a bet and to put the Venture back in Venture Capital.

The angle I press people on is: what macro trends do you believe to be true that the market doesn't realize yet but probably will in the next decade? What companies are playing to that trend? Clear opinions on this can guide you to investments that outperform.

One example of this was the bet we took on Mexico seven years ago; VCs thought we were nuts because they only followed headlines talking about drug violence and hadn't kept up on rising household wealth and engineering+design talent. We had very little competition in finding the best deals in the country and those deals are now ripening - one is up 300x.

Perhaps this could be described as Buffet applied to angel investment - where is there fundamental likely value that isn't fully appreciated by the markets and where you have the patience and appetite to wait for the market to catch up?

I don't see a lot of VCs operating with this kind of flexibility to be truly thesis oriented.

I'm not trying to bash VCs here; for growth capital they are stellar - some businesses really do need tens to hundreds of millions of dollars to mature and that is where VCs shine. Not a lot of angel groups can pull together a $50m deal! There is room in this ecosystem for both angels and VCs; each much play to their strengths to succeed.

> One example of this was the bet we took on Mexico seven years ago; VCs thought we were nuts because they only followed headlines talking about drug violence and hadn't kept up on rising household wealth and engineering+design talent. We had very little competition in finding the best deals in the country and those deals are now ripening - one is up 300x.

It partially comes from discomfort of operating in foreign markets. Developing countries generally also offer an additional risk premium if you get it right (because there is unnecessary bureaucracy, corruption, etc etc)

As an example: I'm European. I think certain countries in Eastern Europe have particular investment opportunities that are super interesting (e.g. Ukraine) but I don't speak much Russian or Ukrainian and I don't fully understand the legal framework.

Even with good lawyers it is hard to go into a developing market you aren't at home in and don't understand and invest well.

Can someone also share the actual steps of going about angel investing? If through my network I hear about a team in say, Africa, looking for investment, do I then ask them to list their project on AngelList? Do I then pay via credit card and AngelList takes care of getting money in their bank? Do I then get some form of legal contract specifying my share of equity? Who enforces the contract?

There’s a bit more structure in place. This is a great overview http://paulgraham.com/angelinvesting.html

I always thought it would be cool to angel “invest” with coding time and expertise instead of money. Any ideas if that’s ever possible? Maybe that’s a good business idea to match up coders with free time to start ups?

Isn't this just the same as startups who hire engineers and "compensate" with equity and don't pay salaries?

Isn’t that pretty unusual? Plus I’d want to be courted like an investor instead of doing whiteboard interviews.

Angels should be willing to take higher risk and their biggest motivation should be innovation not return.

If an investment has outsized returns would it not be due to some innovation ?

Also the purpose of an investment is a return. I can’t tell if you’re being sarcastic or not, but what you’re mixing up research funding with capital investments.

Founders should be willing to take less pay and their biggest motivator should be their name in lights, not traction

Entrepreneur has the best idea ever! He needs funds to build the product.

I believe it's best practice these days to use "they" as a neutral pronoun. It seems like a small thing, but these little things add up.

Fair point! Thanks for looking out :)

I haven't heard of that as a best practice. In my English class in high school they only mentioned to keep it consistent. The preference should be given to the writer. Both men and women have contributed to society so their pronouns can safety be used in written text.

The problem is the male default. Grammatically it's fine, but when hundreds of article default to male, it has a growing effect socially. "They" or "he or she" is typically customary these days, more and more so the former as the latter is annoying to write and the singular they is becoming more accepted as a grammatical change in English.

we need a shorthand s/he :)?

I don't think English is the author's first language -- see the use of "defer" throughout the document. Maybe most polite not to nitpick.

I don't think it's meant as a nitpick but more of a "hey, you may not know this but here's a helpful thing". The comment seems to have been both worded and received in that positive way and that's a great thing if you ask me :)

Or use he or she instead. But yeah, they or he or she is most neutral.

Here’s my guide: 1. Put your money in a wheelbarrow. 2. Set it on fire.

Why are you on this site if you don’t believe in early stage investing?

Maybe tech news? Not everyone cares about marketing and overblown venture capital nonsense

Early stage investing is akin to setting your money on fire. Great if you get a homerun, but likely the story will end with you being out of pocket a significant amount of money.

It's super high risk, with a low chance of success. There are plenty alternative assets to invest in with a better risk reward profile (stocks, acquiring proven and profitable tech products, even cryptocurrencies, and other alternative assets)

This website is called hacker news. Most people here are interested in tech, programming and such. Angel investors and VC people are small minority.

I would think people interested in startup financing/investing are a bigger contingent of HN'ers than you assume. It is run by YC after all.

Perhaps but if you look at most threads, they are very tech/hacker oriented and most commenters, if you read their posts or history, are software engineers here. I think that is at least 70% majority.

Yes, I would agree with you. As an aside, I always find it interesting when a somewhat niche post comes up and you realize that HN commenters also include some folks with very different careers than SWEs - e.g. Theoretical Astrophysicists, Volcanologists, or Wind Farmers.

I like this approach, it has fewer steps and it doesn't waste other people's time.

It doesn't sound well at all.

I think you ought to include more details.

I head that Sequoia uses a cast iron wheelbarrow but those things rust out. The new generation - the AZ16 of the world - uses alloys that are more resilient.

Can anyone comment? Is it true that machine learning wheel narrows are best?

I bought a sailboat. Similar effect, but lower carbon emissions.

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