Many high-net-worth individuals are missing out on one of the most personally satisfying, (and if done correctly) financially rewarding investment vehicles available.
Savvy investors know that it is crucial to diversify their portfolio. Stocks, bonds, real estate, gold, cash, and other technical investments give you diversification of risk, but are rarely satisfying to a high-net-worth individual that is looking to do something meaningful with their wealth.
What’s the investment vehicle?
Investing in early stage ventures (ie. pre-seed startups).
I asked Manish Patel, an avid investor in early stage companies why he does it. While he says: “I’m not the best person to ask because I’m not the typical angel investor.” However, his answer is a common theme that I continue to hear with all angels:
“I get to see them, feel them, touch them… every one of the early stage companies I invest in I know them personally because I can spend time with them. To me, when you have inside deep knowledge in what the team is doing, you have less risk. The fact that I can meet with the leadership team and discuss ideas with the CEO and gain insight into their plans… to me that’s less risky. That inside knowledge mitigates the risk. I don’t get to do that with any of my investments in the stock market. I can’t sit down with the CEO of Wal-Mart and say: “Hey…What’s going on?” To me that’s worth the up front risk and I get to influence the decision making and direction of the company. I love it!"
If you already have lots of money, then getting more money from returns starts to become less and less rewarding. Many non-investors actually think that the primary motivation of angel investors is getting a return on their investment. However, for our angels at Seed Sumo, and from our investor research, this isn’t the only thing they were looking for. They were coming into a “What’s next” moment where they realized they wanted a way to give back and do something meaningful.
“You can’t get love from a spreadsheet.”
Typically we invest in what we know, which keeps real estate moguls and oil tycoons away from angel investing in early stage startups. Angel investing gives you the opportunity to invest in something that allows you to give back while simultaneously getting the lucrative rewards that come with it (if done correctly). Helping to bring something new into the world is very powerful and can change the way millions or even billions of people use products or services.
“Discussing a real estate deal at a dinner party is boring.”
While some will see venture investments as investing in the lottery, others are starting to realize there are business models that work in the angel investing space. You must invest in about 25 companies over the course of 3-5 years. It is a numbers game no matter how you look at it. Now, this can get rather expensive if you use a dart board approach, unless you can latch on with a fund that is doing the investing for you.
"The reason we like the accelerator model of investing is we are able to change their trajectory, connect them and open doors they wouldn't be able to open for years. We also really get to know them and decide which one's we want to double down on. Our thesis is pretty simple. We will look at 1,500 companies this year, invest 50-100k in about 10 of those, work with them for 3 months, and then double down on 2-4 (it's like legal insider trading). Over the course of 3 years, we will have a portfolio of 30 companies that we have a piece of and about 6-10 that we feel REALLY good about. All it takes is 1 to hit and return the fund completely." - Bryan Bulte, Chief Sumo, Seed Sumo
Important points:
- This is a long-term play (average return is 5-7 years) so it isn’t a get rich quick mindset
- This isn’t for every one, ideally you will care about and have some passion for startups
- This isn’t gambling. You actually can contribute and change the growth trajectory of your investment.
- Do not overcommit. You want less than 5% of your investment capital in early stage startup space, typically 1% to 3%.
- Don’t try to pick winners. You need to be investing in a large number of startups to spread your chips.
- Don’t invest alone. Instead invest in an accelerator fund or seed fund that is selecting, grooming, coaching, and connecting your investments and plays the numbers game.
- Don’t invest here until you are already fully diversified with the rest of your portfolio.
- Typical investment managers wont be aware of this investment vehicle, so you’ll want to talk to the fund managers directly or members of the fund to see if you (or they) are a good fit.
- Almost all startups fail, so don’t invest based on your gut. A great investor pitch wont be the reason a startup is successful. Your due diligence needs to include more than just a pitch deck.
- With an accelerator, you are getting in early (usually around $50k for 10%, or $500k in valuation). You can come in later with lower risk and only invest in the seed rounds, but you will be getting much less equity (don't do this).
- These assets are not liquid, so you have to find another reason to get in. It isn’t about a short term return.
- These are not pay-to-play investments. While you may be able to contribute advice to a startup, you shouldn’t expect to be in control, nor should you mandate that they follow it.