Angel Oblivion: Many Angel Investors Are Not Seeing the Writing on the Wall

(Photo: Pixabay)

(Photo: Pixabay)

It’s never good to think and feel that you’re the smartest person in the room. Books have been written on the subject, fortunes lost and movies made. Even UrbanDictionary boasts a definition of it.

I’ve sat in a lot of rooms recently where experienced and relatively successful angel investors truly believed they are the smartest people in the room. In New York City. In Chattanooga, TN. In San Francisco. And even today in my hometown of Boulder, CO.

Disclosure: I’m an angel investor second. I build tools for angels and early stage investors to make better investments decisions first.

My thought: this is not going to end well for the current angel and early stage investors. We should never be the smartest people in the room.

In 2015 Naval Ravikant, founder and CEO of AngelList, wrote a seminal deck about the disruption coming to the angel investment market.

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He might have been ahead of his time, but he was 100 percent right. The disruption is here.

As my work involves dealing with a lot of present-day angel investors I often hear a lot of entitlement, privilege and incompetence that might end really badly. Boy, I think a lot of investors are going to get spanked.

The thing that is most jarring to me is that people who take great risk to invest in companies, which are disrupting whole industries, are vastly unaware of the fact that very disruptive dynamics are gripping the early investment industry.

Today I heard an experienced angel investor tell a startup that was doing a dry-run for a demo day pitch that they didn’t need to include unit economics in their deck because “there will be probably 10 investors in your audience of 1000 at demo day” and they were being too granular and detailed in their pitch.

(Photo: Peter/Flickr)

(Photo: Peter/Flickr)

This is simply not true. Doctors from Maine, engineers from Tennessee and real estate agents from Florida are all investing in startups, whether or not they are accredited or not. There are probably 100 investors in any room of 1000 in the tech industry right now and a 100 other people who are calling their investing aunts, uncles, boyfriends and college buddies with investment tips right after the pitches.

I’ll say again: The retail investor is here. Called the everyday investor by Forbes contributor Chance Barnett, Jenny and John Smith, who until recently invested in stocks, bonds and REITs are now investing in startups. No, they do not have $1MM in assets (not including their primary residence) and they do not make $200,000 per year. The SEC shut the door so she climbed in through the window or even down the chimney.

This is happening. And it’s happening at scale.

We can’t regulate this away. We can’t gripe or hope our way out of it. This is the way it is right now and the trend will only grow. With his appetite whet on the Coolest Cooler and his heart broken for being left out of the equity play after Oculus Rift raised almost $2.5MM on Kickstarter and then sold to Facebook for $2BB, an engineer in upstate New York wants to invest in a startup his frat buddy texted him about so badly that the working dad of 4 will invest half his retirement into a startup because he believes that play will put his 3 sons through college. “Why should everyone else get all the returns” he says to himself?

So why are retail investors interested in this asset class (yes: first-money investing is becoming an asset class according to the Angel Capital Association)?:

  • Partly because of interest rates;
  • Partly because “everybody is doing it”;
  • Partly because some have been burned in the real estate markets of 2007/08 and want to “make it all back” or have made their riches back then and don’t want to miss a chance to double down;
  • Partly because folks like these are promising amazing annual returns:

StartupAngels.co says you can make 27.3 percent investing in this asset class:

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  • David S. Rose’s book on angel investing touts “25 percent or more returns with a well designed portfolio”:

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Yes, everyone says this is a game reserved for accredited investors. And parents tell their teenage kids they cannot have sex until 16 or 18 and you tell your 80 year old dad that he cannot smoke and eat red meat. Good luck with that. It’s much more effective to have a talk about condoms and quality of life.

We need to stop pretending that we’re smarter than others in the room and we need to stop pretending these new folks are not standing on the windowsill ready to jump into what has until recently been our sandbox.

People who are already investing in startups need to be aware of the fact that in order to compete with these new investors for the best possible deals they will have to:

  • have strong deal flow, which can come from building a strong personal or organizational brand;
  • deploy funding much faster, because they are competing nationally and sometimes internationally;
  • be much more proactive and systematic in sourcing investments; the best ones are those you have to go out and find, not the ones that come to you;
  • have access to better quality information that allows for a higher probability of success.

What we need to do, what we have a responsibility to do, is give these folks the tools they need to stop flying blind.

(Photo: Stuart Richards/Flickr)

(Photo: Stuart Richards/Flickr)

So what are these new everyday investors like? These are some of the ones I’ve come across doing vetting, fact checking and due diligence for angel investors just in the last couple of weeks:

  • a couple who are friends of very close and personal friends of mine took out a $20,000 bank loan to invest in a startup;
  • the heads of 4 angel investment associations in the southeast United States credible enough to speak at an angel investment conference have never made a personal angel investment prior to landing their new jobs;
  • an investor loaned $50,000 to a startup founder who will invest that in his startup; they made a loan to a private individual because they are not accredited;
  • angels following Syndicate Leads on AngelList are often investing in startups that have not been vetted because syndicate leads do not have any formal or informal obligations and can but do not have to screen a startup;
  • a real-estate developer who is not accredited (so maybe not all that successful) has already made 4 startup investments;
  • a friend who is a doctor and does not meet the accredited investor status is actively looking for startups to invest in.

Saying that these inexperienced and often unaccredited investors deserve what they get — and I’ve heard this repeatedly from accredited investors — is not really helpful for the industry as a whole.

Why? Because if the newcomers get burned all we’re going to hear on MSNBC and FOX News is how startups scammed Joe and Jenny Smith out of their kids’ college money, with the SEC once again not having their eye on the ball. The real estate and mortage industry heard this for years after the nurses and school teachers lost their life savings on playing the real estate market because “everybody was doing it” and “it was a sure thing”.

We can say: “We told you so” and “We’re protected by the fine print” till we are blue in the face. Disclaimers are everywhere online:

AngelList Investing Guidelines, including disclaimer

AngelList Investing Guidelines, including disclaimer

The retail investors are really here (and actually as of Friday, October 30, 2015 they and their trillions of potential startup investment dollars finally arrived when the SEC voted to adopt the Final Rules for Title III of the JOBS Act.)

But legal or not, these folks are already investing in startups.

Let’s keep in mind that angel investors did $24BB worth of deals in 2014. It was already estimated that The Crowdfunding Industry Will Surpass Venture Capital by 2016 with over $34 billion raised online even before the new regulations come into place. But now that the Title III have been approved expect further rapid growth in this expanding capital market.

According to Forbes Magazine:

[…] Many in the industry foresee that this new class of investors (non-accredited) will grow exponentially over the next 3–5 years into a multi-billion dollar capital market. Long term, it is entirely plausible that we could expect to see non accredited equity crowdfunding grow to surpass angel and venture capital, which do a combined $60+ Billion per year.

So what can we do as angels and those working on behalf of angels and early stage investors:

  • be aware of what’s going on and self-aware of building a healthy marketplace;
  • focus on education;
  • understand that most of the time we lie to each other because cognitive biases screw us up;
  • assumptions and fallacies also get in our way so make sure you work actively on overcoming those;
  • work with each other instead of against each other;
  • play by the rules;
  • make sure we make plenty of space for people with different views, backgrounds and traits — they are of extreme value;
  • care about competing on a level playing field;
  • assume we don’t have access to the best information and that we’re not the smartest folks in the room.

As a community of more experienced investors we need to help these new colleagues make smart choices for the benefit of us all but first of all we need to make sure we acknowledge that they are in fact here and that they are involved in many of the same deals that we are competing for. At the same time we need to embrace that they bring enormous value to our community, not the least of which is much needed liquidity. We all need to be good stewards of this community and focus on good governance.

And we need better tools to provide us with more real (hard-sourced) data as opposed to the self-reporting that’s prevalent in today’s world. New investors might not be aware of some of the fact of life. For example:

  • Right now a lot of the traction on Angel List is unverifiable and it’s easy to get fleeced (important);
  • A lot of startups are running around raising money saying they have teams that are not really in place (people who were never team members or have left the company are still represented as team members);
  • Many teams have prototypes that they call products (prototype ≠ product) and inexperienced angels often don’t know that they need to ask for a look at the source code;
  • Numerous angel investor platforms claim they do due diligence but will only say they have a deal team;
  • There’s a lot of poor quality information out there that people call “data” (important);
  • Lots of stuff put out by startups in decks and one pagers is simply made up.

Information is power. We need access to more reliable sources of information about early-stage startups.

As more and more people start investing in startups the suite of real tools investors will have at their disposal will grow and I hope to be one of those who is building them.

Jakub Kostecki currently runs StartupFactCheck, a due diligence service for early-stage investors that allows them to increase portfolio ROIs. StartupFactCheck is building a forward-looking model to predict startup investment success.

Angel Oblivion: Many Angel Investors Are Not Seeing the Writing on the Wall