Considering angel investing? Here are some criteria to consider:
1. Are you permitted by regulations?
2. Will you have sufficient capital to build a diversified portfolio over 3-4 yrs?
3. Can you stomach the (high) risk?
This is Propel(x) podcast, discussion on investing in all things startups. Startup investing is highly risky. Please listen carefully to the disclosures at the end of this podcast.
Andy Reed: All right. Hi everyone. This is Andy and this is our very first episode of the Propel(x) podcast. So I am excited to be joined by Swati Chaturvedi. Hi Swati
Swati Chaturvedi: Hi Andy.
Andy Reed: And we thought we would start by beginning at the beginning. Who should be an Angel Investor? So let’s get to it. Swati, you’re the CEO of Propel(x), you have a pretty massive background in consulting and investing, and you work with investors and startups all the time. I think that you are a good person to ask this question. Let us go ahead and just jump to who should be an angel investor.
Swati Chaturvedi: Okay. Absolutely. Well, it’s a delight to be here. Hi everyone. So Andy, angel investors, as you well know, are people who invest in high-growth business startups. It is a high-risk thing to do. And assuming you are already investing in stocks and bonds, it is really about portfolio allocation. So you want to consider whether or not you want to add startups to your portfolio. Startups are a form of alternative investment. Typical portfolios have stocks and bonds. If you’re already investing in them, you’ve gone to a financial planner, they’ve told you to put 70% in stocks, 30% in bonds, and so on. But when you add these startups, it changes your portfolio allocation, of course, and they are uncorrelated with the market.
Andy Reed: Because they’re private.
Swati Chaturvedi: Because they are private. And so it could make sense to add them to your portfolio, but they’re not for everyone.
Andy Reed: Right. That’s kind of a leading statement. So then, who are they for?
Swati Chaturvedi: Many considerations go into whether or not you should become an angel investor. It could be to do with the regulations in your country. It could be to do with whether or not you have the money, the ability to set aside to build a diversified portfolio. And it could be whether or not you’re able to take the risks. So it’s a number of considerations.
Andy Reed: Yeah. That makes sense. I think it’s probably good to unpack each of those and it’s probably safest to start with regulations, the most fun of topics. So what are the salient things that people should know about as they’re considering becoming an Angel Investor?
Swati Chaturvedi: Absolutely. Regulations vary by country and of course, we are most knowledgeable about the U.S. In different countries, the government sets different wealth levels for people to invest at sometimes. If you’re above a certain wealth level, you’re allowed to invest versus not. In the US, we have the concept of an accredited investor, which is to say, you either have to have a high net worth or a high income in order for you to be eligible per the regulations to be investing in these kinds of companies. And very specifically, those numbers are; you should have a net worth of a million dollars or more, not including your primary residence, or you should have an annual income — if you’re an individual — of $200,000 or more for the past two years and an expectation of the same in the coming years. If you’re investing as a household with your spouse, for example, then your household income should be $300,000 or more. So that’s an important concept to remember because per our regulation, start-ups or private companies can only have a certain number of unaccredited investors. So the very best startups don’t even go into the unaccredited realm. They stick with accredited investors only.
Andy Reed: And so, one question would be around the accredited investor and opportunities. Are there opportunities for non-accredited investors to invest in start-ups?
Swati Chaturvedi: Absolutely. In fact, that is what the JOBS act and Title III crowd-funding were all about. If you are an unaccredited investor, there are websites that enable equity crowdfunding and those are for unaccredited investors. On Propel(x), as you know, we only work with accredited investors. That’s not to say it won’t change sometime in the future. But for now, we have accredited investors only.
Andy Reed: To summarize most of the companies that you would maybe read about in term sheet or any of the other kind of startup newsletters are going to be only looking for accredited investors. There are also emerging technologies that allow people to invest more in small businesses and those are for unaccredited investors.
Swati Chaturvedi: Yes. More or less.
Andy Reed: Well, moving on, I think one of the more interesting things to talk about is portfolio theory and diversification. You’ve already mentioned having a mix of stocks and bonds and then startups being an alternative asset. How do you think about or how does portfolio construction translate to thinking about startup investing and being an angel investor?
Swati Chaturvedi: At the highest level, let’s take a quick look at how big asset managers like endowments think of it. So they will allocate some to stock, some to bond, some to real estate, some to other alternatives like venture capital, private equity, and so on. And the larger endowments typically allocate 5% to 15% and some of the largest ones take even more risk. I mean, they’re able to take more risks, they have a longer time horizon, they have a higher appetite for risk.
Andy Reed: I mean their time horizon can be a hundred years, so they can stomach a lot of alternative non-correlations.
Swati Chaturvedi: Yes. And the Yale Endowment, we just read that they’re going to be investing 21.6% this year, which is a very large allocation to venture capital. But for individual investors, I think a reasonable range would be to think of 5% to 10% of their investible assets going into startups. I think that’s sensible.
Andy Reed: What would that actually mean?
Swati Chaturvedi: So you have to consider..so..let’s think of it from the start-ups perspective. Each startup accepts a check size of about 25,000.
Andy Reed: For a seed round, right?
Swati Chaturvedi: Yes.
Andy Reed: So early-stage companies are raising a couple of million dollars. They’re going out there, they’re looking for a variety of investors to help fill their round in this scenario.
Swati Chaturvedi: Yes.
Andy Reed: And so here, they’re looking for angel investors to participate. So if you go out in the country and you go to an angel group or you kind of go to your local accelerator, the minimum check size tends to be about 25K. And that’s in part because there are certain regulatory requirements about who can participate.
Swati Chaturvedi: Yeah, exactly..and how many investors you want and so on. But those thresholds have gone lower. Online platforms, certainly like Propel(x) as you know, we accept as little as $5,000. There are platforms that accept lower still, but if you’re investing directly and you met a startup, you’re investing in them. It’s $25,000 range; could be $10,000 could be $15,000, but platforms can enable lesser because we are using technology to make these investments available. So let’s assume you’re investing at the smallest level, right? So you’re investing $5,000 into every startup. Now you need to have a diversified portfolio, which means you need to invest in at least 20 startups, which means that 20 times 5,000, you’re going to be investing a hundred thousand dollars, in about 20 companies over the next two to three years. And we already discussed this should be about five to 10% of your investible assets. So your investible assets have to be at least one to two million before you even get started.
Andy Reed: So that actually goes to those accredited investors. That makes sense. One of the things that I wanted to actually push you a little bit further on was portfolio diversification. So lets say there are a lot of apps out there or SaaS companies, if I had a portfolio of 20 SaaS companies or 20 apps, that seems pretty homogenous. How do you think about portfolios of early-stage companies and diversifying within that portfolio?
Swati Chaturvedi: Wow..So..that gets really detailed, right? I mean, Portfolio theory to the extent is based on public markets. There’s very little data on private markets. So the fact that we are saying you should invest in 20 companies is based on public market portfolio theory. There is very little data on private markets as of today. So to kind of go into that level of detail is hard, and I don’t have a good answer here. But yes, you should be diversified. I mean, you know that there are things that are cyclical so you’ve got to be investing across different types of companies.
Andy Reed: Yeah, that makes sense. I guess one of the last things I wanted to consider was; a lot of people think about..they read the news and they see these mega exits every day and that’s awesome for those people who invested early. But what they don’t read about is other companies that didn’t make the mega exit. So maybe they just came out with a one X return or zero X return. How is the risk? How do you think about risk and private securities and how should angels think about risk in terms of their risk appetite?
Swati Chaturvedi: Yeah, great point. So in fact, there is some evidence on this. There’s data that suggests that long-term angel investing portfolios yield 26 to 28% return
Andy Reed: Was that the ACA study?
Swati Chaturvedi: That was the ACA study, the ‘Angel Capital Association’ study. But that said, there is a large number that will shut down entirely. So when you invest, you should know that. You should just kind of ignore; put this money in and forget. You should be able to forget about it. You should be able to live your life comfortably, even if this were to go to zero. So please you should consider that this is capital that you’re losing and go forward with that point of view. Aside from that, startups have huge risks. So if there’s a startup that’s reporting to you on a quarterly basis; one quarter they may raise millions of dollars, the very next quarter, they may shut down. We’ve experienced such things, right? So it is very high-risk investing and so people should assume they’re going to lose their money. Go forward with that mentality, knowing of course that the long-term return is 2.6 X or a 28% IRR according to the angel capital investment.
Andy Reed: Well, I think that’s a good start. There’s a lot of interesting topics for us to dive into. I’d love to talk to you more about portfolio dynamics in venture capital and how people think about portfolio construction. It’d be good to also talk about deal sourcing, and how to find entrepreneurs, and all the different mechanics. So I’m looking forward to having some of those conversations with you, and also some of the experts that we’ll bring in, who can offer their opinions on these topics as well. So thank you, Swati. I think this gives us a good picture of the considerations of becoming an angel investor. And just to recap those: We talked about accreditation, we talked about having at least a hundred thousand dollars to set aside and, and build a portfolio over two to three-year time period. And we talked a little bit about risk, which is an important topic that I think doesn’t get enough news in the startup ecosystem. So if your answer is yes to all these things, I guess it means that you’re ready to start being an angel investor. And I think one place that we all would encourage you to check out is Propel(x). So more on all of that soon. Join us for our next episode where we talk about how to get started in investing in startups. Until then, this is Andy.
Swati Chaturvedi: Thank you. This is Swati.
Andy Reed: All right. Thanks, Swati. Bye, everyone.
Disclaimer: Propel(x) is a funding platform, not a Broker-Dealer. Securities are offered through Hubble Investments, member FINRA/SIPC, and an affiliate of Propel(x). Private investments are highly illiquid and risky and are not suitable for all investors. Past performance is not indicative of future results. You should speak with your financial advisor, accountant, and/or attorney when evaluating private offerings. Neither Propel(x) nor Hubble Investments makes any recommendations or provides advice about investments.
Content Disclaimer: Past performance is not a guarantee of future performance. The investments mentioned in this podcast (if any) are illiquid and there is no guarantee that an exit strategy will come to pass.