Angel Investors: How They Avoid Risk and Boost Internal Rate of Return

Starting a new business or enterprise requires skills and capital. Skills are self-supplied and capital is either self-supplied or obtained from external resources. Angel investing is the concept of bringing equity investing and entrepreneurship together.

In equity investing, capital or stocks are used to purchase a percentage in business. The capital is returned only when the business is sold. It is like share-holding system, but in angel investing, one person may invest 100% capital in the business. Entrepreneurs can also seek capital gains from angel investors in a running or bankrupt business.

Angel investors make up an important but publicly less-acknowledged part of the market.

According to a study conducted by Freear, Sohl and Wetzel in 2002, angel investors are the most underutilized group of capital market. More than a decade later, the fact still holds true. However, more and more business owners now realize that the knowledge, significance and investment strategy of angel investors directly impacts their business. Successful angel investing leads to successful economic growth in three ways.

  • Angel investing helps small businesses to establish one of the two primary pillars of entrepreneurship i.e. capital. With appropriate amount of funds, the businesses prosper.
  • Strategic planning can help angel investors to increase Internal Rate of Return. An established business sold at higher rate brings increased ROI for angels.
  • Angel investing promotes small business trends and improves national economic growth. There has been 59.2% increment in American angel investing since 2001 to 2011, leading to 106,400 jobs in 2012.

How Angels Avoid Risks and Boost ROI

Most of the angel investors invest in start-up businesses. There are generally two pre-decided ways of calculating ROI. The first decision is of returning 10X investment in certain period of time, mainly 5-7 years. The second decision is to give a significant position among the board members to the angel or provide stake ownership. Here we have addressed some risks of angel investing and techniques of boosting Internal Rate of Rate.

Failure of Invested Business

Failure of a newly started business is one of the most common risks of seed investment. In this type of risk, the angel investor either assigns more funds to the entrepreneur, accepts to bear some percentage of loss, or entrepreneur returns 100% money by borrowing it or getting funds. It becomes tough to access the second round of funds for entrepreneurs and the risk increases for angels.

The risk can be avoided with following techniques.

  • Find out established businesses to invest instead of new businesses.
  • Always invest in your field of experience.
  • Keep emotions aside and never invest in similar business for second round.

Stakes are Difficult to Sell

Angel investing works like stock sharing but selling shares in public market requires converting them into liquid investment. In case of a failed business, angel investors cannot sell their stocks in public market and are bound to bear the loss alone.

  • Invest money which you don’t need immediately.
  • Prepare an exit strategy with the business before investing. The common most strategy is the authority to sell the shares to business itself, even if it is drowning.

Financial Backup

Angel investing culture has been setup by people with high personal net worth. It does not work like donations but it definitely needs good financial backup to support you while the boat of newly invested business floats to the shore. For angels with not-that-high personal net worth, the solution is angel network where they can buy shares. These networks are established by agencies which charge relatively high fees. It doesn’t mean that angel investing is not for small angels. The risks are comparatively lower when working with angel networks as your investment or share is handed over to experienced people. But in case of loss, remember that you cannot blame the agencies.

  • Become a partner of an established but private angel investor rather than investing in angel network.
  • Invest in a business which grants you business ownership. Make sure to invest in your field of experience. It will automatically grant you the authority of decision-making. This is a type of skill-money business with pre-decided percentage of authority to skill-holder and investor.

Slow ROI

ROI may be higher in case of angel shareholding or enterprise ownership but it is extremely slow in case of 10X return. Due to slow ROI, angel investing is a secondary source of income.

  • Always invest ‘free money’ which you don’t need in at least next 5-7 years.
  • Make sure to have a financial backup for fulfilling your daily needs.

Lack of Recognition and Approach

These are probably the only types of angels who need to find their targets. For all other angels, just a prayer works. Anyways, as angel investors are private funders, they do not have any prominent national recognition. Therefore, angel investors are required to step out and find entrepreneurs in need of funding. Nowadays, angel networks have established their online presence for entrepreneurs but remember that in angel network investing, neither the matters are in your hands nor you get full profit and commission.

  • In order to find out prospective entrepreneurs, engage yourself with other angel investors.
  • Portfolio companies are the ones you have already invested in. Always stay in contact with your portfolio companies as these are good sources of bringing more entrepreneurs in need of funds.
  • For online presence, purchase a domain name and optimize it with SEO techniques to get searched by entrepreneurs.

Let’s move on to step-by-step techniques of improving your Internal Rate of Return as an angel investor.

Step-by-Step Guide to Improve Internal ROI

Angel investing might sound like a donation or charity like business but with proper strategy, the angels can completely mitigate the risks and bolster their investments to dramatically improve Internal ROI. Here is step-by-step guide to boost your Internal ROI.

Step #1: Prepare a Discipline

Every angel investor has different goals therefore there is no one formula that fits all angel investors. But you can prepare a discipline according to the following tips.

  • Always select a long and broad list of companies to choose from.
  • Never allow emotions to override your investments or discipline.
  • Do not fall in love with technology, firm or entrepreneur. Again, do not let emotions override business.
  • Do research before making an investment and ask questions of your interest before signing the documents.
  • Always make sure to oversee your investments regularly.
  • Always invest a certain percentage of your funds and reserve the rest for follow-on investment.
  • Make sure to invest in a field of your knowledge.
  • Invest in a company which gives you authority to take part in its decisions.

Step #2: Prepare a Deal Flow

Best returns are driven from best deals. Most f the beginner angel investors invest in the start-up businesses of their relatives and friends. A majority of the angel investors do not advertise their willingness to invest in enterprises. Prepare a deal flow with the help of following steps.

  • Discover your field of expertise. It is not always the field of your study or interest therefore, make sure to choose the right option.
  • Prepare a policy and time frame of exit.
  • Calculate the amount to be invested and make sure to invest not more than 60% of it in the first round.
  • Prepare a list of companies and start contacting them.
  • Meetings and proposals are the keys to start your angel investment business therefore, don’t hesitate contacting and meeting tens of prospect companies.

Step #3: Setting Up a Deal

Once you have selected a company to invest in, make sure to calculate the expected results after your investment. It is important to calculate all options according to changing economic conditions. Also, assess the management team of the company. A well-managed enterprise is a sign of reduced investment risks.

Make sure to review existing contracts of the company and current market position. Before signing the deal, read the terms and policies of the company. Assess the terms to ensure that they favor your advantage. Otherwise, suggest changes in terms.

When signing up the deal, choose the best option. If it is Start-up Company then ask for company’s ownership or significant position in the board. If the management disagrees, then ask them to agree on your Exit Policy or quit the deal. Secondly, if it is an established company then you can invest on the basis f exit policy or 10X return after certain period of time. For successful companies, position in board or enterprise ownership will only bring you extra responsibilities

Step #4: Add Value

After making a deal, add value by establishing good relations with your portfolio company. Keep a track of their decisions and market position and ask for monthly, quarterly, biyearly or yearly analytical reports. In case of red signals, use your exit policy to secure your investment.

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