Outsized risks, outsized gains: How to become a successful angel investor in the unicorn era

#angel investors, #How to series, #startups, here

Note to readers: This is the third episode of a new series of articles, designed to give our readers an edge on matters of competitiveness, upskilling/reskilling and knowledge gathering. Essayed in a lucid, snackable format, this #HowTo series would act as a tutorial, bringing in the most relevant voices on a subject, so that you benefit the most in your business or career. In this article, we take a look at the fundamentals of becoming a successful angel investor, outlining the risks and opportunities in angel investing while also taking a hard look at the common mistakes that most angel investors tend to make. Follow the series here

India may have only around 6,000-7,000 angel investors in the country but every passing year an increasing number of high-net worth individuals (HNIs) are showing interest in the game, encouraged by the enormous success of the tech start-up industry that spawns unicorns every month.

An angel investor by definition is someone who provides financial support for early-stage start-ups, in exchange of ownership equity in the firm. It comes with its own risk, as only a small percentage of the start-ups go on to become a success. It is also highly rewarding if the start-up scales quickly, multiplying your returns in a short span of time.

So, is this a good time to turn an angel investor? Probably yes, if you are one among those HNIs looking to fast track your return on investment and have the stomach for risk-taking. India’s startup ecosystem is one of the largest globally, however, as appealing as running a startup may sound, building a successful one requires commitment, passion, strategic thinking, and most importantly, capital infusion and mentorship. That’s when you need an angel investor to get you off the ground.

While no specific academic qualification is required, an in-depth understanding and expertise of the start-up ecosystem are imperative for an angel investor. It is also essential for aspiring angel investors to identify the right startups to invest in, keep up with the latest trends and updates in the market and learn about financial risk management and investment analysis before delving into the angel investment space, says Nandini Mansinghka, co-founder and CEO, Mumbai Angels Network.

It’s a risky game, but hugely rewarding

Angel investor Sanjay Mehta, founder of 100X.VC believes that while the risk is 1X, the upside may be unlimited. Angels need to be comfortable with the uncertainty of how these start-ups grow or fail and need to be fine with accepting a failed investment, if and when that happens.

The biggest risk is losing all of your investment. It is not similar to real estate investing (hard and tangible assets) or public equities (immediate liquidity). A smart angel investor looks to build a portfolio to mitigate risk. And considering the momentum of the ecosystem (40+ unicorns just in 2021) many retail investors are considering this investment as opposed to other regular assets classes.

This is a high-risk, high-reward, niche investment category. It’s essential to conduct thorough research and have an appropriate strategy prior to venturing into the landscape to ensure a successful investing journey. However, once an aspiring angel investor understands the nuances, it’s just the beginning of a long, rewarding journey, says Mansinghka.

How different is angel investing from investing in general? 

More often than not when you are considering an angel investment, you are betting on the entrepreneur, more than the idea itself. Most angel investors are passive. It is usually the lead investor who works with the founder closely. In India, there are very few full-time angel investors. Angel backing provides an early endorsement of the quality of entrepreneurs, that alleviates uncertainty around the initial stages of development. Motives for investing range from helping new enterprises, adventure, profit or value addition, says Mehta of 100X.VC.

Post-investment engagement with ventures contributes significantly to value creation. An angel investment can add as much “value” from mentoring as it could in actual dollars. This type of close engagement is usually missing in general investing.

What are the odds of becoming successful in angel investing? 

Spreading your investments over a number of start-ups as opposed to parking all your capital in just one entity is one way to becoming a successful angel investor.

One can choose to have multiple investments in one or two sectors of comfort or choose to be sector agnostic. Considering the current environment, being sector-specific and driving value for the entrepreneurs is a path seasoned investors choose to take. Building an investment thesis is important, says Mehta.

Knowledge is key. It’s necessary to familiarize yourself with startup terminologies, legal phrases, investor rights and performance indicators applicable to various start-ups. Joining a startup network can help you to get a better understanding of the market dynamics. Attending pitch days to understand what distinguishes a successful start-up from a mediocre one is another good practice, says Mansinghka.

The capital gains factor

As an investor, your capital gains on public equities are significantly lower than your capital gains on private equities. In India, an angel investor ends up paying higher taxes on capital gains unlike in the US or Europe where angel investors receive adequate cover. Basically, your tax rate on investing in public stocks is 10 points lower than if you are investing in private stocks in India.

So, there is a tax disincentive. “I hope the government corrects this,” says Pranav Pai, founding partner, 3one4 Capital.

What are the common mistakes that new angel investors make?

Not researching enough and yet expecting returns similar to a mutual fund or other asset classes is a common mistake. This is a volatile asset and angels need to appreciate the nature of it. First-time investors need to closely work with their lead investors or micro-VCs to join the cap table. “An additional factor to becoming a successful angel investor is having a good deal flow,” says Mehta of 100X.VC.

It isn’t a lottery. It also isn’t about spray and pray, says seasoned angel investor Sanjay Anandaram. The best-laid plans can go waste. So, odds vary. Inadequate understanding of the sector, the people and other unrealistic expectations are other likely pitfalls.

“This isn’t like picking stocks,” says Pranav Pai. It’s far riskier. A newcomer in the angel investing arena needs to spend time with seniors in the sector and understand the game better. The angel has to think like a portfolio manager and bond well with the entrepreneur, says Pai.

Why is there greater interest from HNIs to become angel investors now?

Earlier, only institutional investors used to invest in this asset class, largely through late-stage PE and VC funds. But now angels and micro-VCs are in the game, especially at early stages. Primary markets have seen a glut of activity with several start-ups going public and many more IPOs lined up for next year.

#angel investors, #How to series, #startups, here
Besides this, ESOPs and exits have created massive amount of wealth for founders and other key employees, who have in turn become angel investors. Family offices have also started looking at angel investing in a big way. The possibility of a 10x return on investment is a real possibility, especially if one goes about the process diligently.

Do I qualify to become an angel?

Angel funds in India are regulated by SEBI under the umbrella regulations for Alternative Investments Funds (AIFs). The AIF regulations have set out certain conditions which have to be satisfied by an angel investor. The investor must have net tangible assets of at least Rs 2 crore excluding the value of his/her principal residence to qualify as an angel or if the investor is a corporate body, then it must have a net worth of at least Rs 10 crore.

How much should I invest as an angel investor?

In India, angels invest from anywhere between Rs 5 lakh to Rs 2 crore. It is said that an investor should not invest more than 5-10 percent of the overall portfolio amount in one company. More eggs, in different baskets. In the US, angel investment usually ranges from $25,000 to $100,000 in a company, though in some cases the amount can go substantially higher.

Says Mehta, “We recommend a model investment portfolio of Rs 2 crore of capital investment over 5 years, wherein an angel investor can invest in 20 companies, a sum of Rs 5 lakh each, totalling to Rs 1 crore. Then have a follow-on round with Rs 20 lakh in five start-ups, which are moving to the next round of funding.”

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