5 Answers to Questions You Have About Starting to Angel Invest
How do you get access? What are the investment minimums? Should you invest in a fund?
Original Post: efficientvc.com/angel-investing-questions (for most updated version)
I get these questions a lot. Like a lot a lot. Questions that I also had when first researching the angel investment space. So here’s an aggregated list of top questions I’ve gotten since starting.
How do you decide to invest in early-stage startups, and how do you access opportunities in that space?
What are the investment minimums for early-stage angel investing?
Should I invest in a fund?
How do you know you’re signing an agreement that is “safe”? Do you have a lawyer review?
How do you transfer money to complete the investment?
1. How’d you decide to invest in early-stage startups, and how do you get access to opportunities in that space? #
Just to quickly explain what “early-stage investing” means, it can be anywhere from idea-phase (pre-product) all the way to pre-PMF (Product-Market Fit). This would usually be a Pre-seed/Seed/Series A (but you are usually getting closer to PMF when you’re raising your Series A), as A and B are more meant for growth - throwing more money (jet fuel) into the jet (the startup).
I particularly like early-stage investing, because it’s usually an early product that is regularly pivoting and building features quickly to see what sticks. This part is fun (for me), as a product person myself, and someone that loves and embraces change. It’s also the area where my product UI/UX skillset is most valuable. Does that sound like you?
But what’s more important is that this is the stage where you (as a customer/angel) can truly stand out to the founding team if you show interest. If you reach out to support, or send over product feedback, you’re likely going to hear back from one of the founders. You don’t get that in late-stage companies. Or if you do, stay away, sounds they aren’t able to delegate or find good talent.
And this rolls directly into how I get access to these companies.
How To Get Access To Deals #
I give a lot of thoughtful product feedback and encouragement.
No, I mean like a literal shit-ton of feedback. Think about the feedback that would be helpful to you if you were building something. Though don’t be confused, it’s not the shitty condescending feedback - if you don’t understand what this means, then you haven’t given enough feedback in general. Or if this is stemming from you not trusting the founding team (feeling like you could do better), then go away, they don’t need you.
To get the point across a bit more, let’s take an example:
You know when you don’t send that email because you feel like you’re being knit-picky and have reached out too much in the past few days? Yeah - I press send. Then send again.
They release a cool feature or do something that you appreciate? Great, write them an email - let them know. Act like you are on their team, even when you’re not. Did they just complete a huge feature launch? Write them to celebrate with them (no, really, this alone got me a job offer at a startup that I loved).
How about an unsolicited Loom video this time? Yep, that too. Feeling uncomfortable yet? Yeah, you’re not sending enough. Others should physically cringe at how much feedback you’re sending over.
Sounds awful for them, right? Wrong.
Imagine building something special. Betting your entire career and life into it. Time that you won’t get back. It’s your baby - it shouldn’t be, but it is, and it’s all you can think about, day-in-day-out.
Now there’s someone that is reaching out to you because they care a lot about what you are building. They are spending a lot of time caring about your baby, your product. They appreciate what you are building, and doing what they can, from afar, to help foster and grow this thing. That’s incredible. You can’t buy that. That’s motivating. You’re giving the founders that. Now that’s special. Seriously, pat yourself on the back right now - good on you.
I’d be remiss to not included an example of sorts…
Here’s the response that I got in a shared Slack channel from the founder of Loops after giving an ungodly amount of product feedback (as just a general user of their product mind you). For further context, this was just after sending over a quick apology for sending over so much feedback to the team over the past couple of weeks:
2. What are the investment minimums for early-stage angel investing? #
It depends on the startup, but there are typically 3 ways to get access:
You can be a large angel (high minimums)
You can get access through a syndicate (and pay fees)
You can convince them to let you directly invest a smaller check (most work involved, but also the most direct and rewarding)
Large Angel (Big Check Size) #
Some will want to focus on having as few people on their cap table as possible (it’s just cleaner and easier to manage that way). Every additional person on the cap table means more work for the lawyers and more documents to get signed once shares are issued to investors. For further context, you don’t actually own shares in a company when you put money into their pre-seed/seed round usually, you’re just signing an agreement, which will turn into shares once a round is priced out. This means that lawyers do their lawyer things, write up documents, determine a share price, and distribute shares.
Yes, you read that correctly, you don’t actually own anything yet.
In this case, it may just be a lead investor (largest check and the one that negotiates the terms), along with a few smaller VCs, and maybe a strategic angel or two (this likely won’t be you if you’re just getting started). In this case, the minimum investment might be somewhere north of $200k.
Access Through A Syndicate (Fees, Fees, Fees) #
What you can do in this scenario, is try to find a syndicate that may have gotten allocation. Often startups may give allocation to a syndicate, which would just be 1 line item on their cap table, and that SPV (Special Purpose Vehicle - which is just a holding company), could have hundreds of investors in it, but that’s up to the syndicate manager to manage. If this happens to exist though, you will get less favorable terms, as there will be added management fees and a carry.
This is typically described as “2/20”, which means 2% management fees (e.g. you’re paying 2% of your investment per year toward the fund manager for them to be supplying you with updates, and managing the deal). And 20% carry, which means that the syndicate manager gets 20% of profits that come after your initial principal is paid back, once the investment is finally sold.
Let’s take an actual investment for example, because this feels confusing as hell - believe me, I’m still wrapping my head around it all.
Say that you invest $10k
And after 7 years, it grows to $110k, and the company exists (IPO/Acquired)
Great! You get paid back your initial principal investment of $10k
And then the fund manager gets their 20% of the remaining $100k (your gains) for $20k
This leaves $80k (your profit)
So your $10k investment that grew to $110k actually turned into $90k when there was a 20% carry in place.
And this is how syndicates make money. Imagine a $200k allocation turning into $4.2m across the fund. The syndicate manager gets 20% (after paying back the principal). That’s $800k.
(And let’s not forget the management fees either, as that’s anywhere from an additional 1-2% per year that you’re paying to the syndicate)
The more in-demand the company, and the more layers of convolution, the worse the terms might be. I’ve seen 3/30 (which is awful), but this is what you might expect to see for a company like SpaceX popping up in the secondaries market (a second-hand market early investors and employees to prematurely sell some of their shares).
And this comes from many layers trying to make money along the way. So you might have a VC buying someone’s shares, and then a fund on top of the VC offering access with fees. After all is said and done, with everyone taking their respective piece of the pie, you’re at an up-front fee + 3% annual management fees + 30% carry. It’s absurd. But you want to get into SpaceX secondaries? That’s the cost (plus you’ll need to know the right people and trust them, in order to get you access). Trust is critical in this space.
Convincing Them To Let You Directly Invest (Smaller Check) #
Typically, you can expect to see a $10k minimum if you are doing a direct investment. I’ve seen this as low as $1,000, but the company has to be using some type of investment vehicle like a Roll-Up Vehicle (RUV) via AngelList, or a community round via WeFunder. When you do it this way though, it’s more like the company is creating its own syndicate (with low or no management/carry fees), to get its customers or community to invest. And in this case, you aren’t a line item on their cap table.
If you directly invest, you will show up directly on their cap table. “Alex Bass” will be written, right alongside the big boy VCs. Not gonna lie, it’s pretty cool to see that.
3. Should I invest in a fund? #
If you have no access and absolutely no idea what you are doing, yeah, only if you trust that the fund has a general partner(s) that have more access than you. And then you just need to weigh the fees/carry to determine if the access is worth the cost.
Investing in a fund is like taking many small bets, hoping that 1 or 2 hit and become 100x returns. If this happens, you can expect a fund to pay out somewhere between 2-4x your investment. You’re not going to 100x your investment by getting into a fund, you only do that by making a big gamble directly into a startup. But, making 2-4x over 7 years is way better than losing everything, which is more likely to happen when you’re investing directly.
The general rule of thumb is, that you should make 40+ investments over your investment career. That gives you decent odds at 1 of them hitting big and making up for the 37 failures and 2 “okay” exits. To be clear, you can still lose everything, lots of people can invest into 40 shit startups. There are hundreds of thousands to pick from.
Fund Minimums #
Some early-stage focused funds will usually have a $20-50k minimum. Sometimes this is paid out over the course of 4 quarters, 25% per quarter. This happens because funds slowly deploy the capital over time, so they don’t actually need the money up-front. You may put in the first chunk in Q1 so they can invest it in Q2, then Q2 for them to invest in Q3, and so on.
4. How do you know you’re signing an agreement that is “safe”? Do you have a lawyer review? #
After finally making the decision to make my first angel investment, this was a question that wracked my brain for weeks. So… I’ve decided to send off $35k to a random bank account. How do I know that I’m not getting scammed right now?
Well, the answer to that is trust. Trust and the standardized YC SAFE Agreement (much of the time at least).
What is that might you ask?
YCombinator has done us all the favor of creating some standardized agreement templates for early-stage investing. The magic line from the agreement that gave me the trust to sign and send over funds (all without having to consult a lawyer):
This Safe is one of the forms available at ycombinator.com/documents and the Company and the Investor agree that neither one has modified the form, except to fill in blanks and bracketed terms.
Boom 💣 - pretty magic line, right? By signing this agreement, we are both agreeing that it hasn’t been modified from the website, and the lead investor (who is often putting in hundreds of thousands, if not millions of dollars) is also signing the same agreement.
This contract means that we are totally safe, right? Because it’s the standard contract that most startups sign?
Wellllllll… You see… This agreement is written in such a way that prioritizes speed and benefits the startup, not you (the investor). Whaaaat?
Yeah, essentially a SAFE agreement means that you are agreeing that in exchange for sending over money now, you’ll have the right to buy a percentage of the company shares once there is a priced round. This usually happens at a Series A, because by that point, if the startup was to go under, they likely would have before that, and thus, tons of money was saved on lawyers and paperwork to issue shares to all of the investors.
Yeah, to put things in a different perspective… Startups die so quickly, and speed is of the utmost importance, that this contract is the most commonly used, so a startup can quickly get money, to get to some level of product-market-fit, before they have to deal with the legal logistics of managing shareholders.
That also means, if there is never a priced round (e.g. Series A raise), you’ll never actually own the company you just invested in. They can straight-up decide to turn into a lifestyle business, become profitable, and never actually issue shares to anyone.
While a slightly different situation, (because they did have a priced round and shares were issued), have you ever heard of Gumroad?
Sometimes you invest in a company that you’re hoping becomes a unicorn, and instead, they turn into a decent lifestyle business. A complete and total failure for everyone (aside from maybe the founders, depending on how you want to look at it).
So yeah, be prepared for something like that to happen, especially if all you’ve done is signed a SAFE agreement.
But that’s the risk of early-stage investing. It’s more likely than not that the startup will just burn through their bank account, trying to achieve PMF, and die. So no need to worry too much about the lifestyle business path 😬
5. How do you transfer money to complete the investment? #
I’d be remiss to not say something about this because in all of these conversations you’ll have, and documents you read, everyone and everything says that you need to wire funds over to the company when you’re ready to go.
At the time I used (and loved) the Neo bank One Finance (they were acquired by Walmart and suck now) – anyway, they didn’t allow for sending a wire transfer. And plus Wires are more confusing (you mistype a SWIFT number and that money is sent who knows where, and good luck dealing with getting it back) and expensive (they unnecessarily charge you like $20-30 for it).
Well, let me be the first to tell you that you can usually get away with simply sending over an ACH transfer from your bank. It works beautifully if the startup is using a modern bank like Mercury. Don’t be afraid or feel silly asking.
And if the company isn’t based in the USA or accepting USD, Wise works like a charm for converting to different currencies and then transferring funds (again, no wire transfer needed!)
Feel free to message me on Twitter if you have any questions that wasn’t covered here.
Until next time!
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