So far in our lessons we have talked about the risks involved with angel investing. The safest assumption when you angel invest is to assume you will never get your money back, and to be pleasantly surprised when you see returns.
That said, as an angel investor you are investing with at least part of your goal being to make a return. You want to try to mitigate your risk and create a balanced portfolio.
It’s easy to get too wrapped up in portfolio strategy before making your first investment. Your first investment is all about learning. It should be small, and should be meant to help you get a taste of the investment process. However, to start designing a portfolio strategy it is good to start by thinking about how much money you can afford to angel invest over the next 2 - 3 years. By your second investment, you should have a pretty good idea about your portfolio strategy; the number of investments you plan to make and at what amount.
In order to determine how much you can afford to put in each investment, take the number you want to allocate over the next 2-3 years, and divide it by 20. This is widely seen as the minimum number of companies you should invest in if you want a chance at a balanced portfolio.
For example, let’s say you can afford to invest $200,000 over the next two years, investing in 20 deals would mean an average investment of $10,000. However, if you decide to invest $100,000 over time, that would mean $5000/deal, over 20 deals. It’s always good to first consider is investing across more companies rather than putting more in a single company.
What if you want to start out slow and even after making your first investment you aren’t ready to commit a large amount of money to angel investment? Can you still be an angel investor? Absolutely.
Our hope is that this course will set you down the path towards being a lifelong angel investor, and we don’t want to scare you away by leaving you thinking that you need to commit to hundreds of thousands of dollars out the gate.
Platforms like AngelList allow your investments to start as low as $1000. Let’s say you feel comfortable committing to angel investing $20,000 over the next 2 - 3 years. With that budget, you can still create a diverse portfolio, by investing $1000 in 20 AngelList deals.
Here are some quick rules of thumb to help you think about portfolio building:
Plan to invest in at least 20 companies
Diversify your portfolio, don’t just invest in one sector and geography for example, you will be exposing yourself to more risk if that geography or sector experiences a downturn
Invest over time, don’t plan to invest everything in just a few months, plan to spread your investments over time, say 2 - 3 years.
Make consistent bets, invest the same amount of money across all of your deals. You do not know which ones will be successful.
Every angel is different, you may choose to invest varying amounts in your deals, or invest in fewer deals than 20, and that may be the right strategy for you. Start with an amount that you and you are comfortable with, gain experience as you go, learn, and adjust.
As part of your exercises for this module, you will be developing your own customized portfolio strategy to start you off.
To close off this lesson we’re going to talk about how you as an investor will track the success of the portfolio you are building. Early stage investors tend to measure the success of an investment using two metrics:
Internal Rate of Return (or “IRR”): The IRR of an investment is the discount rate that makes the net present value (or “NPV”) of the investment’s cash flow stream equal to zero. A project may be a good investment if its IRR is greater than the rate of return that could be earned by alternate investments of equal risk. IRR requires breaking out the calculator, but Cash-on-Cash (or “CoC”), our next method for calculating portfolio return is very straight forward and we’ve actually already been using this method to talk about returns throughout the course.
Cash-on-Cash Return (or “CoC”): CoC is simply how much the VC receives in proceeds upon exiting the investment divided by how much it initially invests in the company. For example, if you get 100,000 in a liquidity event after investing 20,000, your cash on cash return is 5X. Unlike IRR, is not dependent on when the exit actually occurs. IRR tends to be more important to VCs than angels. And CoC tends to be more important to angels than VCs.