Passion Pays. Angel investors must aim for at least 8-10 deals

Angel investing has taken off in India in a big way in recent months. In early 2014, on an average, around 10 angel deals would be reported a month. From the second half of 2014, the angel space has seen a rising trend. The monthly deal count crossed 30 in August 2015, and has remained in the 30-40 range since then; an increase of about three times in a year.

The spurt in news flows on start-up investing seems to have caught the attention of the average high networth individual (HNI). For every HNI who is already an angel investor, there may be five new investors actively considering this asset class.

But before you jump on to the bandwagon, ascertain how many investments you want to, or will be willing, to make.

This is a vital point, since unlike normal investment avenues that allow exposure to fixed income or secondary market equities, where entry and exit are relatively easy, angel investing is a very time-consuming and involved activity.

Neither entry nor exit is easy when it comes to angel investing. Finding a transaction is not easy, unless you become part of angel networks, or have already made several deals, and the market knows you.

Having found a likely deal, the process of evaluation, negotiation and deal closure can take a minimum of three months in a best case scenario. Once invested, be prepared for an average holding period of at least three years.

In the face of this seemingly arduous task, the HNI might think, “Let me make one or two investments, and see if it is worth it”. That would be just the wrong approach, as it ignores the risk inherent in the start-up asset class. Says Vikram Chachra, a veteran angel investor who has made over 20 such investments.

“I think four out of five start-ups are destined to die in a normal environment and the casualty number can be even higher, when there is a funding slowdown.”

Given that start-ups will naturally be the most vulnerable type of companies, mortality is bound to be high. I have seen a few cases where people have made one-two investments which haven’t worked out, and that’s been the end of their angel investing foray.

“Angel investment is a high-risk investment class. If the equity class is like a jungle safari to you, then trust me, angel investment is the extreme adventure sport, not for the faint-hearted,” says Archana S Awasthi, a Mumbai-based angel investor.

To mitigate the risk of start-up failure, one needs to aim for a minimum number of companies in your portfolio.

“Building a portfolio is very important because it’s very hard to hit a bull’s eye on your first shot. A portfolio allows you the luxury of being wrong and takes multiple bets on those outlier ideas, which provide outsized returns,” says Chachra.

A good thumb rule is to aim for a minimum of 8-10 investments. Seasoned angel investors tend to have much more than that.

There are several investors in India now with 20-40 companies in their portfolio. Have they gone berserk? Not quite; they are simply following old fashioned portfolio diversification philosophy. Even if you look at the secondary market, most mutual fund schemes or HNIs’ portfolios created by wealth firms, will have 20-30 scrips. If in the secondary market risk mitigation is important, it is equally so in start-up portfolios.

There is one important difference in angel investing though. While in the secondary market, diversification typically means spreading risk across sectors, in angel portfolios, it tends to be concentrated. This is because, unlike investing in the secondary market, where the investor’s role is passive, investors tend to play an active role in start-ups.

With meagre resources, start-up teams are often short on expertise. If an investor can add value to the start-up, it benefits both the company and the investor. Besides, in a start-up, the investor often has to work towards an exit, particularly, if it is via strategic sale. “It is important to know your strengths and keep your investments in that area,” advises Archana.

Building a portfolio of 10 investments implies an ideal allocation of around ₹1crore. That will allow you to make some large investments, along with a few small investments of ₹5-10 lakh each.

Most investors tend to start with small investments; often as part of an angel investing group. Several such groups exist now. Once investors become more comfortable with angel investing, some venture out into solo investing, or take the lead investors’ role.

This would normally require a larger investment size of ₹25 lakh or more. Also, companies normally do not want to deal with too many investors. Given a choice, they would like to take a few large investors, rather than several small ones.

Besides money, expect to allocate time as well. Finding 10 companies to invest can take two to three years. If you are considering an exit horizon of three years, you are looking at a five-six-year cycle for your first set of 10 investments. So, why still do it? Same reason people do adventure sports. It can be addictive and rewarding if you do it right.

The writer is partner at Wisdomsmith Advisors LLP, which also runs an angel platform, Wisdom Angels

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