[Editor’s Note: This is a republished post from Passive Income MD (PIMD), the newest member of The White Coat Investor Network. PIMD is all about finding financial freedom through creating additional income streams. Angel investing is very risky but may be highly rewarding in the right situation. However, you don't NEED a high level of risk to meet your financial goals. Living like a resident for 2-5 years after training, 20% savings rate and boring Vanguard index funds can do that. The original post ran here, but if you missed it the first time, it’s new to you! Enjoy!]
What is An Angel Investor?
An angel investor is usually a high net-worth individual that provides capital for a start-up business, usually in return for equity in the company.
Typically, an angel investor needs to meet the SEC criteria of an accredited investor. The reason these investments are usually limited to accredited investors is that the SEC and government want to do all they can to make sure that investors can weather the total loss of capital.
Sound familiar? Angel investing has risen to the public eye on the TV show Shark Tank, and if you’ve seen the show, then you have a pretty good idea of what an angel investor does. Of course, this show presents a much more dramatic version of real-life angel investing, but the concept is the same.
So, they proceed to present their business to an angel investor.
In days past, it could be quite difficult for a business to not only raise money, but to gain access to a network of high-net-worth professionals looking to invest. The same is true for the investor; finding worthwhile companies to invest in required having an extensive network. However, with the different crowdfunding laws that changed because of the JOBS act in 2012, businesses looking to raise money can now also utilize crowdfunding, similar to those looking to raise money for real estate deals.
Why Invest?
The reasons a person might become an angel investor can vary, and sometimes it’s a mix of everything. To be honest, one of the top reasons is that there can be some very high returns.
Obviously, angel investors are looking to make a good return on their investment. Considering their level of risk in investing in a start-up, they’re usually looking for returns in the order of 10-50 times their investment.
On the flip side, many investors may have the entrepreneurial bug, but their day jobs might limit their opportunity to follow through on it. Investing in a startup may be the next best thing, as it allows them to participate without all the hassle of the daily grind.
For the investor, the ideal scenario is a combination of all three: you make money, participate in something you find enjoyable, and watch a passion of yours succeed.
But really, how often does that happen?
Downsides of Angel Investing
The idea is appealing, isn’t it? Who wouldn’t like to imagine that they’re Mark Cuban or Chris Sacca and invest in the next Uber or Facebook? However, the reality is that angel investing can be very risky.
Every company in which I’ve invested has clearly stated that there is a real possibility of losing your entire investment. Needless to say, if you’re going to engage in this type of investing, you need to go in with eyes wide open.
Most angel investors will invest across a good number of companies in order to mitigate potential losses. In fact, success rates seem to be similar to that of opening a successful restaurant – only about 10-20% of companies seem to “make it.” VCs use the same strategy, but they also have the advantage of selecting the best deals and having a team of people vet the deals prior to investing.
If you want to read some more about why you shouldn’t be an angel investor, just read Financial Samurai’s article.
Reduce Your Risk
Still thinking of being an angel investor? Then you need to reduce risk however you can.
Some ways to do this include investing only in people you know, investing in an industry you know something about, and investing in companies to which you can truly add value, either through your expertise or connections.
Have I Personally Done Any Angel Investing?
The answer is yes. I’ve invested in several companies, and I’m considering investing in a medical technology company as we speak.
Two of the more interesting companies I’ve invested in have nothing to do with medicine. They are:
- In 2016, I invested in a website called Inverse.com. The site is geared toward the millennial male, which I am not, but I’m a bit of a tech nerd, and I enjoy reading fun, tech-driven content. The same founders sold their previous website, BleacherReport, and I was a huge fan of theirs since then. I invested a very small amount, but enough to make it interesting.
- The second is a direct-to-consumer wedding dress company called Floravere, which people are touting as the “Warby Parker” of wedding dresses. I’m convinced that every retail sector is prime for disruption, and the wedding dress space is one that hasn’t experienced that… yet. I know the people running the business personally, and I’m betting on them just as much as I am the business.
With any investment, the hope is that they will do well. In fact, if I didn’t at least think that these investments could be home runs, I wouldn’t have invested in them. However, my mentality is that this money is locked and non-accessible for the future. No one likes losing money, but if neither of these amounts to anything, it will not change my life.
Summary
I believe physicians should first focus on creating a nice, diversified portfolio of investments – both in real estate and the market particularly using tax-advantaged accounts. People should reserve angel investing for a time when they have the capital to lose without worry. If losing that money will keep you up at night, even for a few moments, then it’s not for you. It just isn’t worth it.
In reality, physicians shouldn’t need to hit a home run through angel investing to accumulate wealth and retire early. You can otherwise get there by smart, consistent investing, particularly in investments that yield passive income. You can always supplement your income with side hustles as well.
However let’s be honest, I wouldn’t be doing it at all if a small part of me wasn’t hoping for a nice windfall years down the road. It’s great to dream, after all.
Ultimately, the decision is up to you. If you’ve considered being an angel investor, just keep in mind that’s not all glamorous. Weigh the risks, and if you go through with it, mitigate them as best you can. And who knows? Maybe it’ll pay off in a big way.
Have you ever angel invested before? What’s your experience been like?
I haven’t angel invested before, but there are several groups in my town that meet regularly. Meetings usually consist of networking and listening to presentations from hopeful startup founders. Volunteer committees analyze potential investments and conduct due diligence together. In addition to the opportunity to invest in local startups, a fringe benefit is the opportunity to build quality relationships with other accredited investors.
This kind of investing leaves me so torn. It is really so much like buying an individual stocks with a susbtantial amount of capital. Really, I’d never encourage someone to do that because regardless of what kind of analysis was performed to judge how much that company is worth, the risk likely won’t be worth it in the end.
That said, in person business decisions where you get to be a part of the decision process or in supporting something you personally know about seems like I am investing more in myself. In these situations I am not having to depend on valuations of the market, but I do have to depend on what I think others will think of the business. I’ve always wanted to invest in a brewery since I know a couple of professional Brewers. That’s my pipe dream for down the road a bit. We will see if I ever do it!
The key really is to make sure your potential profit truly is as great as the risk of losing every dime you put into an angel investment. Ideally, you’ve thought through the likelihood of making that profit and it stands a good chance. But you must be okay with losing it all and it not detailing you.
Sure, doctors should have the option. It isn’t required and it shouldn’t be a large part of one’s portfolio. I have enjoyed such investing over the years. It takes only one big winner to pay for all the losses and then some. I use the NNT “barbell investing.” Most money is safely invested, but some is wildly speculative. Think Tim Ferriss wealth from all the startups he invested in. Doctors definitely underestimate the risks though. Caveat Emptor
Can you elaborate on what you mean by “barbell Investing”?
He’s using the term differently from how it is typically used, which is to refer to a bond portfolio composed of very short term bonds and very long term bonds but not intermediate bonds. He’s referring to having a bunch of low risk investments and then a bunch of high risk investments. Perhaps Tim Ferris used it that way.
Tim Ferriss does, but I think it was coined by Nicholas Nassim Taleb in Black Swan
Is there a particular route to get involved in angel investing? Is there any way besides just word of mouth?
With the advent of crowdfunding, there are plenty of opportunities out there. Of course a lot of the high-end VCs probably get the best opportunities however recent success stories to come out of crowdfunded angel investing include Coinbase, Dollar Shave Club, and Instacart. A couple of my favorite sites are Fundersclub, & AngelList. They offer funds once in a while to diversify your risk a bit. There are also clubs that have formed amongst higher income individuals and you may want to look for those if you’re interested with pooling money with like-minded individuals.
How much time do you spend overseeing their business? Do you get frequent reports from them? What kind of due diligence have you done in the industry of wedding dresses or websites for millenials? Or do you just trust them to manage as they will, because you trust in them as people? Clearly there is a premium for investing in a company before it gets big-you can get exponential returns if they manage their business right. You’re investing the way the rich do, in private equity, and at least you’re avoiding paying a huge fee to a hedge fund manager by investing directly with the company and avoiding a middle man. But, you may be more savvy than the average investor. Is Warren Buffett wrong for investing in individual companies? No, but that’s his business, and he does it better than anyone else. For someone who doesn’t have the level of understanding to do this type of business analysis, then it is not investment, it is speculation.
On the subject of doctors, they just as any one else have all the options available to them if they choose. But those who want to stick to publicly traded investments (which should be most of us), a small company tilt, or a liquidity factor tilt may give this type of exposure. I believe that Vanguard has a new factor ETF that solely is based off the liquidity factor. However, I’m not investing in this, coz I’m not very imaginative and I don’t know how to mix it into my 80/20 portfolio with broad index ETFs and DFA funds. I have not yet done any real estate sleeve, but Origin investments seems interesting if I want to do private commercial real estate some day. I am concerned that real estate valuations are too high to do that right now. Other speculative people are looking into commodity investing or bit coin. I haven’t done any of these either. I’m sticking to what I can understand.
I started a forum topic about angel investing but the thread didn’t pick up any steam. https://www.whitecoatinvestor.com/forums/topic/angel-investing/ Today’s article might benefit from more substance, but that issue *was* discussed ad nauseam on the forum.
I’ve looked into joining angel clubs, but they require minimum yearly investments and active involvement in evaluating deals. I would be ok dropping 50-100k on a couple projects, but doing that year after year (not to mention likelihood of requiring additional funding) is out of the question for me. For the involvement piece, I do have the interest in learning about opportunities, but I don’t have the finance/law background that the co-investors want.
The founders are also looking for connections in addition to money and ongoing support. PIMD mentions Shark Tank and this is a great example–the start-ups will use the cash, but their real “win” is having an investor who can get them on to QVC or call the guy who stocks widgets for Walmart or email the gal who makes the essential part of a left handed smoke shifter. I’m not the one to help them with that stuff.
I will consider an Angellist fund when they open another. This could be a good compromise for folks looking to angel invest. I suspect the folks running the fund will be the biggest winners, but perhaps there will be some cash leftover to roll down to us peons–and maybe gain a little education at the same time. Also, while the upside will be limited, hopefully the downside will not be at zero?
A site that I found useful is called http://www.equityzen.com. it’s not strictly limited to Angel Investing as you can certainly also participate in the subsequent rounds of financing for more mature companies such as series A through C or more….
They have companies of course that are actively raising and ones that have raised in the past and you can get on an alert list for when they start again. There are some pretty well-known companies on there such as DocuSign, Evernote, Realtyshares etc.
I believe the lowest investment minimum I’ve seen is $10,000 so that would make it much easier to construct a small portfolio of various Investments which is really what you want to do in this space given the known High rate of failure.
M23 here,
Around the time ESI inspired me to write about ‘being’ a millionaire (#23 of the Millionaire posts here), I realized that I now had met the requirements of an accredited investor (a million bucks net worth, exclusive of personal residence). That’s when I looked into Angel Investing, and have been having a ball doing it, so far. I’ve made 13 investments, all tiny, since diversification is so important (totals around 2% of networth right now).
To expand on a previous post, minimums for many types of angel investments are often $10,000 (due to number of investor limits) however the new crowdfunding laws allow companies to dramatically reduce the size of equity crowdfunding to $500 or so. Most of my “13” are only $1,000 bets. I’ve used sites like SeedInvest, Crowdfunder and AngelList to gain access to ‘deal flow’ and other seasoned investors who are helping to vet these investments.
To find out quite a bit about groups that can help you on your journey, consider consulting the Angel Capital Association, a national organization that helps foster Angel Groups all across the US. There is quite a bit written to help you on your angel journey https://www.angelcapitalassociation.org/new-angels/
I’ve helped get a couple breweries up and running with small five-figure investments. It’s fun to be part of the inner circle on those. I’ve gotten an inside look at how a small startup is run and the challenges they face.
I’ve also gotten to brew a batch on a 15-barrel system, and I’ve enjoyed my share of “liquid dividends.”
Cheers!
-PoF
I have posted about this before. My angel investing experience was BAD. I joined a local group for about $1500/year. (This was prior to crowdfunding.) I enjoyed the meeting. The people in the group were interesting. Lots of members had started businesses that went public. Lots of patent knowledge. I was on a due diligence committee of a biofuels company. I invested in a company that was developing a new type of incubator for neural tissue. It had a patent. I invested $15000. Most of the group was investing. Then the CEO of the company walked into a room full of university professors and shot 6 people because she was denied tenure. She is serving life in prison. A TV movie was made. The company bankrupted. I decided not to do any more angel investing.
Whoa. That is BAD. Thankfully, I’m sure, also rare.
yeah, definitely takes a stomach to Angel invest. Deep pockets and diversification are key. As an Angel, you have assume that you will lose 9 out of 10 times, with only 1 in 10 providing 90% of your returns. You have to invest based on little information, the time horizons can be between 5 and 10 years of your money tied up, often with little or no news from the entrepreneurs. Even my risky 13 investments only adds up to 2% of my portfolio. Anything over 10% of your net worth is almost irresponsible in this class of investment. I am told that 15-30 investments is necessary to statistically have a responsibly diversified angel portfolio.