Angel investing (2): what happens next

Angel investing is not for the faint hearted. In my previous post in this series, I discussed the onset of the angel investing journey. In this, second, post I’ll take a look at ‘what happened next?’ across a series of my angel experiences. Truly, this is the Hindsight post.

Instant Riches?

What you’re hoping for, simply put, as an angel investor in a seed business, is that you’ve just backed the next Google/Facebook/Amazon/take your pick. You’re hoping your investment goes on to become a ‘Unicorn’, i.e. valued at above $1bn.

In the world of venture capital the professionals are generally looking for ’10x’ – i.e. making 10x their money – which often implies the business ends up, after taking on further rounds of investment, becoming a Unicorn.

One of my best ’10x’ investments is company T, shown below. OK, so it didn’t quite make me 10x (though see below). But it exited quickly – the key money back came in month 53, with a small (15%) amount retained for a further 12 months.

You’ll notice that I added to my initial investment in month 23. Whether to ‘top up’/’follow on’ your investments is one of the hardest decisions you have to take in investing, in my experience. In the case of company T, I’m glad I did – even though by so doing my multiple fell (i.e. my month 23 investment was at a higher price than my month 0 investment).

Company T was one of the best angel investments I know. But nonetheless, one of its investors was really p*ssed off when it exited. Why?

Or a tragically early exit?

To get a glimpse of what might have been, consider company A – which was one of the best venture investments of all time. Company A made its investors 67x their money, in year 9. This worked out as 74% ‘internal rate of return’ – compound growth, in other words – for each year. It is this sort of return that is so alluring about investing in early stage technology businesses.

While company A was astonishingly successful, its IRR (annual return) was only a tad higher than company T’s. Company T exited after around 5 years. If it had maintained that annual return for another 3-4 years it too would have delivered a 60x multiple. It is this missed potential that frustrates the aforementioned company T investor.

Ultimately, a Unicorn

In reality, your ‘average unicorn’ takes a lot longer than five years to reach a billion dollars of value. Take company V, shown below. I invested early in this business, not once but twice in its first year. Then with a small top up a few years later. The business has gone on to become a unicorn business. But it has taken over a decade. 11-12 years later, I have taken out around 9x my initial investment. My remaining stake is worth, apparently, a further 20x my initial stake. It may take another few years before I can sell it.

I invested in Company V when its initial valuation was around $20m. Since then it has become a unicorn, worth more than $2bn – over 100x more. Yet my initial investment has ‘only’ multiplied by 10-30x. What’s happened here?

The answer is dilution – because it has raised a lot more money on the way up, and I didn’t always participate in those further investment rounds. This is a very common situation with fast-growth tech businesses. The lesson? Don’t immediately assume that your mate who was one of the first investors in Deliveroo/Monzo/Revolut/Farfetch has done quite as well as the valuation would suggest.

There is another point to make here. Yes, I invested in the early days of a Unicorn. But that was over 10 years ago. The IRR here is between 20-30%. That is good, very good, but not off the charts – especially considering the lack of liquidity I’ve had along the way. Amazon’s share price, when I invested in company V, was around $40/share. It’s gone up 50x since – a better return even than my unicorn investment.

The fast flop

Early stage angel investing is notorious for companies going belly-up. Sometimes, that happens almost instantaneously after launch.

Take company B, for instance. One of my most ignominious and embarrassing investments. I invested for all the wrong reasons. Less than 6 months later, the business folded. That isn’t even my fastest flop, sadly.

And while I’ve highlighted the Fast Flop, the much more common variety is the Slow Flop. Usually a seed investment will be part of an investment round designed to last 12-18 months. It will usually take at least a year to know that your money has gone to a very dark place.

The hungry zombie

The next example is an important one. This scenario illustrates a very common dynamic in angel investing.

As I mentioned above, the hardest decision to make as an angel investor is whether to ‘follow on’. In company T’s case, I have followed my original investment no fewer than four times, over 6 years. My subsequent investments have been smaller than the initial one, but nonetheless I have now invested more than 2x my initial investment. There is no hope of any immediate money back, and I estimate my holding is ‘worth’ less than my initial investment.

Company T is basically a cash sink. But it still exists, and in fact has probably reached a point where it won’t or barely will need further funds. But it isn’t worth much either. A likely outcome is that it gets bought for paper/shares, and the acquirer then goes bust. But this is 1-2 years into the future.

Why did I invest in months 22, 24, 47? Was I expecting this time to make a big return? Was I an idiot? Was I being forced to invest to protect my rights? Did I remain the one true believer in an obviously forlorn cause?

In fact for one or two of these investments, if I hadn’t invested I would effectively have lost my rights/position. But in general my motivation wasn’t strictly financial. I invested, originally and subsequently, to support a friend of mine. I once had pretty high hopes for the business, but by month 22 I knew I wasn’t going to be dining out on this investment. Since then I’ve been investing amounts that I can afford, primarily because I’ve been asked to, and my relationship with the founder means I have wanted to say Yes.

In the meantime, there is no liquidity, no visibility, and no reward from this investment. Just the occasional moment of dread when a shareholder update lands in my inbox.

The dream machine

More positive, on the face of it, is the type of business that I am calling here a ‘dream machine’. This type of business, illustrated below by company S, appears to be doing brilliantly. On paper, my investment in company S is showing an internal rate of return (annualised return) of over 100% per year, over 5 years! In theory my initial investment of £50k is now worth over £1m.

I say “in theory” because the only basis for the valuation of company S is the paper valuation it is claiming based on recent investment rounds. As you can see below, I did not participate in any subsequent investment rounds. And as anybody who has followed WeWork’s recent fall from grace can see, paper valuations set by venture capital investors may not be grounded in reality.

In practice, the most obvious next step with company S is a brutal return to reality. Investors will be asked to cough up more cash, or lose their exposure almost completely. If I’m not prepared to throw good money after bad, my bad becomes terrible.

As I said, angel investing isn’t for the faint hearted.

VC Plod

My last example is also a relatively common example.

My money went in many moons ago, along with a very prestigious venture capital (VC) investor. Many, many moons ago. 175 moons ago, in fact. This was a very promising business, already profitable, which appeared likely to skyrocket to a mega IPO. In practice the controlling shareholders had very different ideas, and a lot of internal shareholder squabbling resulted. At some point many of the investors decided they wanted to sell their investment, but there wasn’t a way for them to do that either. We all waited, and waited. Ultimately, we achieved an exit. After 15 years, at less than 2x our money. That rate of return – 4.2% – is lower even than Zopa/FundingCircle.

The grim reality of angel investing

The examples in this blog are real, admittedly with company names/dates/etc hidden to preserve confidentiality.

The examples here are not uncommon. If you speak to an experienced (10+ investments, 10+ years) angel investor, he/she will recognise more than one of these examples.

What these examples illustrate you is several uncomfortable truths about angel investing:

• You have no liquidity. There is usually no ability to choose when to exit an investment. You may be able to choose whether to sell, but you may not – as was the case in company T.
• Your initial investment may prove to the first of many. If you fall in love with a business, and want to clear out your live savings to buy as many shares as possible – you are an idiot. Especially if it comes back asking for more, and if you don’t cough up you lose your existing rights/position.
• It take ages. Many, many moons. You won’t know whether you are any good for at least 10 years. Even if you luck out or bomb out in the first 3-4 years, you can’t form a view on your performance for 10+ years.
• Your millions won’t buy champagne. Your stake may appear to be worth gazillions – it may actually be worth gazillions – but without liquidity there is practically nothing you can do with it. Champagne bars will not accept your paper shareholdings as currency. And, more often than not, your incredibly valuable stake will turn out to be worth quite a lot less than you first had indicated.
• You can obtain these returns in the public markets. If you manage to invest early on in an Amazon, an ASOS, a Microsoft, a Fever Tree, an A2 Milk, etc you can achieve returns that would make most angel investors blush.
• Just one pinch-yourself-amazing investment can make you enormously rich. My biggest angel investment is £100k. If only I’d put £100k into company A, and held on all the way to exit, I’d have made over £6m on that investment – which would have been several times more than my total ever amount invested in angel investments. Too bad I didn’t.