Starting a company is one of the most worthwhile and rewarding things that you can do. Not only are startups the most effective supplier of new jobs for our economy, but you can learn more by building one from the ground up than what you would learn in any MBA program (whether you are successful or you fail — in fact you probably learn more if you do fail).

Supporting such a startup I suggest, is second-best, but also a very worthy practice. In February, I posted A Guide to Angel Investing exploring what an Angel Investor is for both prospective Angel Investors and Entrepreneurs. In this post, I would like to back up a little and take a look at; if a prospective Angel should even be one.

I have many friends that have been richly blessed with great business success. Some have started their own companies but most were either professional managers within wonderful companies or were fortunate enough to have a family business that they grew up in. They are all very successful in their own right. Having said that, starting a company and running and growing one are two different endeavors. Not everyone can do both. It is important to know what you are good at – and not so good at (and what you like and do not like to do), a personal SWAT analysis of sorts.

Make a Difference

Early on, I was fortunate enough to become a member of the Young Presidents Organization (YPO), now merged with its “graduate organization” WPO. One of the things that my WPO Forum group has helped me with was developing balance in my life. Many of you have heard me define “half-time” as 12 hours per day. They also assisted me in developing a personal vision statement and the goals to support it. Part of that personal vision is “to make a positive difference in my world”.

After selling my last technology company, LeanLogistics, to an international public company a couple of years ago, I went about developing an informal network of mentoring and investing opportunities as I looked for my “next thing”. Those are a couple of the vectors that I have chosen to help make that difference and have some fun along the way.

Good Returns Require Many Investments

Investing in early and seed stage companies can be a great way to diversify your investment portfolio and enhance its returns; however it is very risky and difficult to access good vetted investment opportunities. The Kaufman Foundation has some great Angel Investor Performance data here. The data supports the fact that an Angel Investor needs to invest in many deals to help reduce their portfolio risk. Kaufman found the average cash-on-cash return was approximately 3.2x (total dollars returned divided by total dollars invested). This sounds like a fabulous return; but you need to understand that the median returns vary dramatically with the portfolio size due to the outsized gains from a few wild successes — and many failures. Ah, if we could only predict which would be successful beforehand.

Specifically, they illustrate that going from 5 investments to 10 investments increases median return by 68%, from right around 1x (you get your money back) to nearly 1.7x. Going from 10 to 15 increases median returns by another 40%. Doubling portfolio size from 15 to 30 adds another 50%. This supports the need to be involved with many investments to have a hope of a meaningful return. How would you expect to have a positive return if only 1 out of 10 of your investments will have a great return and you don’t invest in at least 10 companies? This was one of the reasons that I helped found Grand Angels, a West Michigan-based band of Angel Investors. Today I am involved with the two Michigan Accelerator Funds with the hope of making even a larger impact – and helping reduce my investment risk along the way.

If you are going to invest in early and seed stage companies I think that you need to look objectively at your own skill set too. Entrepreneurs are the quid essential optimists. They have to be. The impediments to creating and building a successful company are huge. The world is just not set up to help you succeed and an entrepreneur has to have the passion and optimism to break through their inevitable barriers.

Good Angel Investor Predictors

I would submit that there are a few predictors for being a good Angel Investor, they are:

1. If you have started or run a company before. You know what to look for as you have been there yourself.
2. You are patient. It always takes at least 2-3 times as long as the entrepreneur thinks — and more to get to a liquidity event.
3. You are going to invest in at least 30 companies (see my comments about returns above).
4. You are completely comfortable with not getting your money back, ever. You will sleep better.

I have seen too many Angel Investors that do not meet these criteria and they often become frightened and disruptive investors. The last thing a struggling company (and all startups struggle at one time or another) needs is to have to manage a panicked investor when they need to be focused on success. I know, I have had to do it.

Now you know why I am involved and investing more thru and with targeted funds. It is the best way for me to invest more effectively, broadly and professionally.

Important Work

Our economy desperately needs innovative and successful entrepreneurs and their companies to help create our future. To do so we also need dedicated Angel Investors who are willing to invest their time, money and efforts to help empower their success. We all depend on it.