How Do Angels Deal with High Risk Investing?

How Do Angels Deal with High Risk Investing?


Angel investors make decisions to invest under conditions of extreme uncertainty. Angel investors face cases in which uncertainty is so extreme that it qualifies as unknowable: they decide on investments in ideas for markets that often do not yet exist, and they propose new products and services without knowing whether they will work. For experienced Angel investors rather than being undesirable, unknowable risks are deliberately sought, on the basis that it is by investing in companies with unknowable risks that they can find the most attractive, most profitable investments.

Experienced Angels do not seek to maximize each decision but instead seek potentially extraordinarily profitable opportunities and accept a high failure rate. They rely on building a large portfolio to spread risk and accept that the overall failure rate, by number of investments, may be as high as 70%, even in the most developed capital markets[1], with 85% of all returns coming from just 10% of investments made. They are willing to accept that most of their investments will be total losses.

A key role for “training” therefore needs to be providing nascent Angels with an understanding of the characteristics of the Angel market, tactics to deal with the high risk, and thus confidence to join with others in making their first investments.

Experienced Angel educators suggest that individuals new to Angel investing tend to seek out training on subjects such as valuation, looking for the “correct” valuation method or formula, reflecting a desire to reduce uncertainty (and perceived risk). In practical terms valuation training will likely highlight that there is no “right” answer, instead presenting a number of different methodologies, and suggesting that several should be used in each case and the results compared, but that local comparatives are likely to be the most significant influencer. Many of those new to investment struggle with this lack of a definitive answer but gain confidence when they see that all Angels face the same issues.

[1] 2016 Angel Returns Study, Angel Resource Institute, 2016.

Angel Decision Making – How do they get to Yes?


Reading the available  academic research and discussions with experienced Angel investors suggest that “technical” subjects (valuation, financial modelling, technical due diligence) play a relatively limited role in the overall decision-making process, significantly due to the lack of “hard facts” in so many aspects of an Angel type investment. It is not a formalistic driven process. There is no proven formula for success, and no hard data to put into a formula should one exist.

Rather, decision making is based on a mix of technical analysis and intuitive assessment (what Angels frequently refer to as their “gut feeling”), with recent research suggesting that intuitive assessment is favoured over technical analysis[1].

The typical Angel decision making process begins with a subjective assessment as to whether the investment is likely to ‘fit’ with their personal investment criteria rather than a technical analysis. This may include location, amount sought, knowledge of and interest in the sector, and their own ability to add value.

Experienced investors rely heavily on their prior experience and previous investments to inform their present decision making and typically prioritize their intuitions about the entrepreneur over process and “hard fact” (e.g. business viability data).  Finance, in terms of the financial structure of and projections for the venture, is the most important criterion for both nascent and novice Angels but ranks only fourth for experienced investors[2].

The Learning Process

Investors who may now be classified as experienced consistently said that initially investing with other, and then more experienced, Angels had been their most valuable source of learning.  A number added that they had learnt more from failed investments than successful ones!

This suggests that the most effective way to improve the skills of new Angels is through engaging with experienced Angels in actual real investments. How do they get that engagement? Join an existing, active local Angel group, attend their meetings, help with the due diligence and join in a few syndicated deals.


[1] Managing the Unknowable: The Effectiveness of Early- stage Investor Gut Feel in Entrepreneurial Investment Decisions, Laura Huang and Jone L. Pearce, Johnson Cornell University, 2017.

[2] Heuristics, learning and the business Angel investment  decision-making process, Richard T. Harrison, Colin Mason & Donald Smith, 2015.

Nelson at the Peru VC Conference June 2017


A fantastic experience talking at the Perue VC Conference – Amazing people and a fantastic location for the event

What Is It Worth? Valuation of Investments


Valuation is probably the most emotive issue to be addressed in any investment negotiation.

Both entrepreneurs and investors seek reassurance that they are not agreeing to an inappropriate (unfair) valuation that will result in them receiving an inadequate share of the anticipated future exit proceeds. Both seek to find definitive valuation techniques that will give them the “correct” valuation. Both are often attracted to the more mathematical, formula based valuation methods involving discounting future values of potential exit values to present day money values.

While many of these methodologies have some merit, it is appropriate that whatever valuation they suggest, that this is sense checked against what is happening in the local market at the time of the deal. Always compare proposed valuations with other comparators in the local market. If you and the company are not based in Silicon Valley then Silicon Valley valuations are largely irrelevant.

Bill Payne carried out a valuation survey of US angel groups collecting pre-money valuation data for pre-revenue company investments from 35 angel groups in 22 states. He found that valuations ranged from $0.8 million (Boise Ohio) to $3.4 million (Silicon Valley), with an average valuation of $2.1 million. The survey showed wide geographic variance, with, perhaps not unsurprisingly, Silicon Valley, New York City and Boston showing the highest valuations, and Idaho, New Mexico and perhaps surprisingly, San Diego at the lower end.

There are a number of factors that likely result in these regional variations. The nature of the business will have an influence, with Biotech, life science and medical devices typically funded at higher pre-money valuations than, say, software and Internet companies. Increased competition among investors for “good” deals will tend to drive up valuations. Valuations in Silicon Valley are driven by the need to have much larger investment sizes because of the significantly higher cost of operating a business there.

However the size of the investment round seems to be one of the most influential factors.  Some investment rounds can be for £2 million or more, while others may be for £100,000 or less. Since angels typically prefer purchasing less than a majority ownership, a higher pre-money valuation is more likely for a larger round size. 2016 valuations may have been up at $3.6m (notably down from a high in 2015 of £4.5m), but the Angels still took 22% of the equity

The Angel Resource Institute’s annual report (The HALO report) on Angel activity in the USA constantly shows that while valuations vary both by geography and by year, the amount of equity taken by the Angels remains remarkably consistent at between 20% and 30%.  So a higher valuation does not result in less equity dilution of the founders.

Having empirical data on local valuations will provide extremely valuable in the negotiation process, providing a “reality check” to both aspirational values put forward by entrepreneurs and “scientific” valuations produced from mathematical formula. Angel groups should seek to cooperate in collecting and sharing local valuation data to ensure their own investments start out on a solid foundation.

“Investor Ready” is not enough


While numerous enabling programs exist, offering services in business planning, technical development, market analysis, financial forecasting, etc., few enabler managers or entrepreneurs have been through the fundraising process.  As such, most “Investor Ready” programs fail to prepare entrepreneurs for the actual capital raising process.

Entrepreneurs are left facing various challenges, including:

  • Inability to identify an appropriate source of capital
  • Lack of understanding of common investment instruments
  • No understudying of, or preparation for, the investment process. What happens after a pitch?
  • Misalignment of priorities between the investor and entrepreneur
  • Limited knowledge on due diligence requirements
  • Misalignment of structure and valuation
  • No focus on the exit event for investors

The lack of preparation and ability to effectively engage investors contributes to a perception of poor quality “deal flow”, which is a hindrance to attracting individuals to become Angel investors, or to consider investing in certain locations.

Additional training is needed to help prepare companies not just to be able to pitch to investors, but to prepare them for the investment process – screening, due diligence, valuation, deal structuring, the content and impact of the legals, and critically, the post investment relationship with the investors. Such sessions should also help to break down the barriers resulting from lack of trust some founders have in potential investors, a lake of trust significantly resulting from a lack of understanding of the process.

The Myth of the VC Series A for Angel Funded Companies (or any others)


Very few Angel investments receive follow on funding from venture capital firms.

According to the University of New Hampshire, Centre for Venture Research there were around 75,000 Angel investments in the USA last year. Yet the PWC Moneytree report recorded just 5,004 VC deals (of which 33% were in the San Francisco area). So even if every VC deal had previously had Angel funding, that would still be a tiny fraction of Angel backed companies going on to secure any form of VC funding.

CB insights reported that 68% of USA and European successful technology company exits had received no VC funding before the exit.

These numbers are supported by the research in Scott A. Shane book “Fools Gold? The Truth Behind Angel Investing In America”, (Oxford University Press, 2009). “Fools Gold? is possibly the first book to bring together hard data on angel investing within the USA from multiple governmental and academic sources, including the Internal Revenue Service, the US Census Bureau, the Federal Reserve, the Kauffman foundation and many others. The book so encourages Angels to invest as part of an Angel group, and encourages policy makers to invest in supporting the creating of angel groups. This to facilitate a portfolio style of investing and the pooling of investment funds to provide larger amounts of funding over a longer period than would be possible as a solo investor.

Fundamentally Angel investors need to plan for the Whole Life funding of their companies. They cannot just assume that future funding will be provided by some as yet unidentified VC. They must therefore crowd in as many investors as they can into the first and other early rounds, even where this means each individual investor investing less into each deal than they could, or would like to. Only in that way will there be sufficient future reserves of capital to fund the likely 4 or 5 rounds typically necessary to get to a successful exit.

“First Mover” is not a Strategic Advantage.


Far too many times I see company barely past the idea stage claim “First Mover Advantage” as a justification (or at least a major one) for their proposed pre investment valuation.

More likely, this should go on the other side of the evaluation equation – it’s a disadvantage.

  • “Google? Not the first search engine.
  • Facebook? Not the first social network.
  • Groupon? Not the first deal site.
  • Even in the mists of software industry time: MS-DOS – not the first operating system.

It’s not about having the idea first – it’s about having the best execution of the idea. Who can quickly and effectively engage with a profit paying customer base. It all comes back to the effectiveness and skill of the management team. So when doing due diligence look for real evidence that this management team have the experience, and skills and focus needed to rapidly engage with a critical mass of paying customers.

Angel Investing – Not Just for the Supper Wealthy (who are usually not very good at it anyway).


The Best way to be an Angel Investor? Become a member of an established Angel Group of Network and join in lots of deals with other members, investing just a little initially in each one. Let’s say a company was looking to secure £250,000. That should be provided not by one of two really rich individuals, but by 10 or more individuals each investing between £10,000 and £40,000. Why? Because Angel investing is very risky – as many as 70% of the Angel backed companies in the USA fail to provide a return to the investor – so the reality is, however good that pitch looked, no one, however experienced they are, can pick the winners.

Angel investing can be highly profitable, with organised angels with a portfolio investing strategy achieving IRR returns of 25% (and one Angel friend showing a 101% IRR!). But you must do a lot of deals. Less than 6, and the probability is you will not get any return. You need to be planning to do 15 to 20 new investments over say a 5 year period, recognising that many will not manage to develop as planned. Then be prepared to provide follow on funding only to those that do show real development and in particular customer traction. Don’t keep funding the ones that don’t perform (and they will likely be the majority!). It’s only after the company has been actually operating for a few years that you will have any chance of starting to see which ones are likely to be the real winners.

And the only practical way to be able to invest the necessary cash, and time, across such a large number of investments is to do it as a “team sport”, investing with as many other Angels as you can, providing small amounts of initial funding each, and then building on the successes with more capital. A good rule of thumb is that for every £1 you provide as an initial investment, you need to plan on providing another £3 for follow on into the “good” ones.

Being part of a group has many other advantages.  Usually better access to deal flow as the Group will be better known than individuals, certainly more people and brain power to do screening and due diligence and access to much more post investment support.

And why are the Supper Wealthy usually not very good at it? They don’t share the deals, and put too much money into too few companies, and don’t have the time to provide adequate post investment support into a properly sized portfolio. Better to be a team player.

The Queen’s Award for Enterprise Promotion 2015


The Queen's Award for Enterprise Promotion 2015“I am extremely moved to have receive such an important and prestigious award”

The prestigious Queen’s Award for Enterprise Promotion has been awarded to Nelson Gray, a renowned angel investor and board member of LINC Scotland, the national association for business angels in Scotland.

The Queen’s Award for Enterprise Promotion, recognises individuals who have played an outstanding role in promoting the growth of business enterprise and/or entrepreneurial skills and attitudes in others. It is part of The Queen’s Awards for Enterprise. adobe cloud day-trips . HM The Queen bestows the Award on the advice of the Prime Minister who is assisted by an Enterprise Promotion Assessment Committee.

As an active business angel, Nelson has directly provided numerous start-up and early stage entrepreneurs with funding, support and mentoring.  He has also been a key player in the development of a vibrant business angel community in Scotland, and in helping the LINC model achieve widespread international recognition and adoption.

Speaking on behalf of Scotland’s angel community, David Grahame the Executive Director of LINC Scotland says everyone involved in angel investing is hugely pleased to see Nelson’s contribution recognised with a Queen’s Award. “Over the years Nelson has been a superb champion for the angel community in this country and his activities overseas both for LINC Scotland and as a GlobalScot have helped angel groups around the world set up networks based on the Scottish model.”

Sandy Kennedy, chief executive of Entrepreneurial Scotland added that Nelson’s broader contribution to promoting entrepreneurship has also been significant.  “Nelson is passionate about supporting young people and he was a founding member of the Scottish Institute for Enterprise, set up to help students in Scotland discover their entrepreneurial talent, as well as a long serving board member of The Entrepreneurial Exchange.”

Less Sweat – More Equity. Maximising the value of your business


I recently read an account by William Draper 3rd, one of the foremost VC’s out of Silicon Valley, of a meeting he had in London back in 2005 with two young men, Niklas Zennstrom and Janus Friis, about the future of their company. The two entrepreneurs were looking for advice as to what to do next:

  • Sell
  • Merge
  • Stay on the current path

Draper had been one of the first seed investors in the company back in 2002.     When the entrepreneurs eventually decided to accepted the eBay offer for Skype of $2.6 billion his initial investment showed a 1,000 X return. Not bad for three years work.   A great investment story – yes. But perhaps not just because of the massive return on investment – by now I am sure we are all used to receiving 1,000 X.

OLYMPUS DIGITAL CAMERANo, it’s a great story because the company and the investors were able to have a conversation about their choices – sell, merge or stay on the current path.   They had built a company that understood its value in the market – that therefore had the capacity and nerve to consider not taking the $2.6 billion.

Unfortunately too few companies I see have been built in terms of time, management or cash to leave themselves this choice. Or any choice.    The more normal scenario is that it’s taking longer than expected to hit the next milestone or land the customer that will allow them to get to breakeven cash:

  • The cash is running out fast
  • The investors are tired
  • Prospects of another round of funding are non existent
  • The burn rate is too high, but they cant cut staff or they will look even weaker.
  • The dream of the start-up a few years ago has become a nightmare – Why did we give up the day job?

According to a report by NESTA – that’s the fate of around 56% of companies receiving angel investment in the UK. (A report done in the US by the same team suggested a failure rate there of 55%).    Now a failure rate of close to  60% – and I suspect the numbers may well be worse than that if investors were really to own up as to what is happening out there, is pretty bad news for investors……

But it’s a catastrophe for the entrepreneurs concerned and not to good for the country in terms of lost opportunities for jobs and wealth creation.   I don’t believe that all these companies were “bad companies”.    I don’t believe they all had poor management, ineffective technology or flawed business models.

No – I think the issue for many is they have not thought out their strategy properly – over the long term – they have not given themselves options –

“If we get to point B, we can a) secure new funding to get to point C, or we can  (think of options)-  sell our IP, or we might fit with company Y or (think of more options – other than shutting down!)…………….”.

Too many just get on a funding treadmill without thinking about the implications of the next funding in terms of valuation and dilution, or whether the objective they have set themselves actually create real value, either in the eyes of future funders or future acquirers of the business.  Sure, there may be a general strategy that some day there will be some kind of exit – it had to be in the business plan after all –  “by way of a trade sale or an IPO”.

It was kept a bit vague, because they did not really spend much time thinking about it, and the investors thought it would make them look too much like a VC if they asked too many questions about how they were going to get out before they got in.

Chances are that neither the entrepreneurs nor the angels have ever actually had an exit, so it’s kind of hard to know what to ask anyway.   The only thing we all really know is that if only we lived in the USA it would all be so much easier.

I am also sceptical of the argument that you read fairly frequently at the moment that the drought of exits and liquidity is the result of recent recessions. I might be persuaded of that if we were able to look back to pre-recession days and see evidence of a “golden time” for such activity. If there ever was such a time I seem to have missed it.

This is not about forcing an exit, or selling out early. It’s about having a clear understanding of how to create real value in a business, and how to ensure that you have a choice as to when you realise that value:

  • If you decide its time to retire
  • You decide you wish to do something else – start something else
  • Your personal circumstances mean you need to find some cash
  • You wish to spend more time with your family / fishing / or being an angel investor.
  • Or you just want to sleep better at night knowing that you could sell up if you needed to, or wanted to.

Having an “Exit Strategy” allows you to have an “Options Strategy”. Having options increases the probability of success for all parties. wsyr9   And to develop these strategies you need to have an understanding of what’s really happening in terms of exits.

What does it really take to push the company through an IPO?   Who is actually buying companies, and for how much? When you hear of a company being acquired, what is it in that company that is attractive to the acquirer?   The problem is there is just so much misinformation flying around.

If you read recent technology blogs it is easy to see reports that the “IPO window is now open again”.  IPO

  • “2014 was the most active year for IPOs since 2000” Actually this translates as….
  • “In 2014 the total number of IPO’s (NYSE & NASDAQ) was 273”.

Admittedly this is up on the 222 in 2013.   Of these 273, 126 were VC backed.   Fewer by Angels.   In 2014 there were 4,356 VC deals reported and an estimated 70,000 angel deals.

So perhaps no surprise that “we will exit via an IPO” gives entrepreneurs little credibility in the eyes of investors.

SO – it’s going to be a trade sale?

“We might not be the next Google – but we can sure as hell be bought by Google – and all be rich. All we need is £20 million of funding to prove the model and scale it up”.   The only fly in the ointment is that, according to Charles Rim who was until recently Google’s head of M&A for Asian markets:

  • “90% plus of our transactions are small transactions. So that would be less than 20 people, less than $20m – that is truly the sweet spot”
  • “we do prefer companies that are pre-revenue”
  • “technical staff, engineering, a strong engineering team, these are the things that we think are very important…..”

This I think is the key to developing the options strategy.   A real understanding of what the customers for your business (as opposed to the customers of your business) see as really valuable.   In the case of Google they are saying that they want technical and engineering excellence formed into a team that can work together – and subsequently work together within Google.   So it looks like if the acquiring company for your business is likely to be Google, or someone similar you’ve now got a clue as to what you should be concentrating resources on building. webhosting information .   You also have an indicator that if the likely exit is going to be around $20 million there is not a lot of point in sinking $20 million of funding into

These metrics will be different for different industries. But the principle of really understanding what those metrics are for the industry you are in must be at the heart of strategy development.  In life sciences for example…

  • Just how far do you have to push the project before you can get the interest of large pharmaceutical companies these days?
  • What data do you need?
  • How does this vary between the different potential acquirers?
  • When you list the companies that might be interested, do they have any money?
  • Have the ever actually bought anyone else?
  • If they have, have they done so in this geographic area?

By having a clear understanding of the answers to these questions businesses can ensure that they invest their resources in the most appropriate way to build real value.   Value that can if they wish be realised if that is their preferred option for the future.   This understanding will help in developing the growth strategy and funding strategy.

Bluntly, will the current proposal to raise an additional £500,000 in order to achieve a targeted level of sales or the development of a new technology feature actually add value to the business? Or is this simply going to dilute the entrepreneurs and existing shareholders?

If Google is happy to buy a company for $20 million, or for $100 million, but the not interested in anything in between, then you need to plan accordingly so as not to end up somewhere in the middle.

As entrepreneur or investor, as an individual, group or syndicate of groups, have you really worked out if you have the fire power to reach that sweet point for your potential acquirers?

If not, may I suggest that the development of your “exit options” strategy is a priority at your next board meeting.