This article was first published on Der Shing’s Blog.
Frequent readers, friends who know us, or fellow members of AngelCentral will know that Shao-Ning & I are careful risk-takers. We don’t just think of upside but rather deliberate methodically before investing and we also have parameters and systems set up for our investments so that we get to the right risk-reward we want.
Recently, we had to write down an angel investment that was on paper a multi-bagger and which was worth >$1M on paper if we sold it. Please don’t ask us which startup as it is not professional to reveal. The entire area in which this startup operates obviously was badly hit by covid.
Anyway, the point of this post is not to gripe about the painful paper loss, rather it is to share that this setback actually validates what we have been teaching and practicing for angel investing.
So here’s a recap.
1) Bite sizing matters
We have a cap of about $200K per startup and have increasingly standardized first and follow-on bite sizes. By not being greedy and following round after round on winners, we prevent any overly painful loss when there is a need to write down. Of course, the bite must still hurt if lost but it should never kill you. The only time you invest all in for something is when it is your startup.
2) Diversification matters
We set a goal of 4-6 startups a year with a target of 25 every 5-6 years. Each set of 25 can be viewed like a VC portfolio and we hope for 1-2 big winners that pay for everything and account for the 3X return after 10 years. During the holding period, some will grow and die. But our thesis is to never sell until the founder sells. This last point does merit further debate since technically portfolio returns can be even better if we sold out and realized the 1+M profit. But then what if this is the startup that goes on to grow 5X or 10X from here?
On a broader portfolio level, diversification also means don’t overinvest in any one asset class. Startup investing whether as an Angel or via VCs should not exceed 10% of what you have. If you are super on, then not more than 25%. And if you have a lot sitting in startups, please invest in blue chips, property, bonds, and other much safer instruments for the rest of your portfolio.
3) Put it at book value always
This is something quite different from others that we practice. So while we have to mark to market so that we can compare with VCs and also use it for workshops, we actually always put the value of the startup in our overall portfolio spreadsheets at the value we invested in. We even write down if we know realistically not doing well and may die. We only write up if realized. This practice really showed its value this time as we did not have to really write down our portfolio value by 1+M, rather we just wrote down the value invested which is quite small. So psychology-wise, this book value recording for startup investments helps keep us grounded and also ensures our leverage use is always based on conservative asset numbers.
And for completeness sake, we updated our angel portfolio to reflect this writedown and now our IRR since 2015 for the 31 startups we directly invested in is now 35% with a 2.4 TVPI. Still good for us as it matches top-quartile VC and within our projected return goals.
Hope this is a useful read for fellow angel investors.