Introduction

I began angel investing roughly a year ago. Generally, people say that feedback on early-stage investment decisions takes 7 - 10 years, but in reality, investors often have a good idea of how their start-ups are doing soon after investments are made (unless they don’t request information rights, which, unfortunately, is common among individual angels), especially when things are going poorly. There are definitely a lot of valuable lessons to be learned from mistakes, or rather, trials by fire.

The Untold Lessons

1. Bad Start-ups Die Early

Angel investors often find that bad investments quickly go to zero, while good investments take a long time to offer returns. This can make angel investing seem discouraging. In reality, this is perfectly normal, as the primary cause of start-up failure is running out of money.

Many people blame Australia for having an immature ecosystem that doesn’t adequately support start-ups in their growth and scaling phase, preventing them from reaching an escape velocity akin to Uber. I beg to differ - I believe that start-ups which are prudent with their spending are difficult to kill. This gives them a much better chance to find product-market fit and greatly improves their odds of raising capital down the line.

This segues perfectly into my second point.

2. Follow-On Isn’t Less Risky By Itself

I’ve listened to many podcasts featuring angel investors and even venture capital general partners sharing their investment approaches. The most common strategy seems to involve splitting capital in half, with the first half invested broadly in start-ups, giving them the option to invest more later, and the other half used to invest in the successful ones from the initial spray and pray.

One strategy that seemed obvious to me was investing in start-ups raising their follow-on rounds directly without participating in the first round. My first two investments were made this way - I didn’t think too much about it. Now, looking back, I wish I had been more cautious.

I’ve realised something that no one told me before - all companies try to raise follow-on funding. However, only the bad start-ups can’t raise and then die. Follow-on is not inherently safer - according to Michael Kim, GP of Cendana Capital, the survival rates of start-ups that raised pre-seed and seed funding are the same. Yet, you tend to invest at a much higher valuation for follow-on investments.

I’ve lost faith in this approach and have completely abandoned it.

3. The Damage of Light Due Diligence

Perhaps I’ve been lucky. I crafted my angel investment approach in Sydney Angels, which encourages a very rigorous due diligence process. The due diligence for one of my favourite deals took around four months to resolve all issues related to IP, go-to-market strategies, and valuation. This might sound excessive to many investors and may even feel off-putting to many founders. But at the same time, it has an edge in attracting deep tech and highly serious founders.

When I networked with other angel investors, I was surprised by how light the due diligence could be for some of the deals they invested in. I heard about a deep tech investment that was made, and after hearing what the tech promised to deliver and looking at the founder’s profile, I was 99% convinced it was a scam (think of a perpetual motion device designed by a business person). There are numerous other examples, like a term sheet stripped of all minority investor protection clauses, or where founders had been convicted by authorities for fraud, which were not picked up. These were extreme cases, of course, but generally, a lot of angels seem to hold a mix of philanthropic and lottery-buying attitudes towards their angel investments. It’s unfortunate to say that red flags, which could’ve been identified through due diligence, only have downside risks without any upside gains.

On the other hand, angels and investors who lack the capability to conduct a comprehensive due diligence process might choose to avoid certain types of deals altogether. This can work in favour of investors who possess such capability. For most deep tech deals, addressing intellectual property (IP) alone is a significant task, and we typically involve an IP attorney in the deal to raise questions about patent families and assist founders in becoming more thorough with their IP management. Aside from IP, the path to commercialisation for deep tech significantly differs from traditional start-ups in B2B SaaS and marketplaces. As a result, generalist investors often view perfectly legitimate deals with meaningful upsides unfavourably.

Another interesting observation is that investors review hundreds of well-crafted slide decks on a daily basis. Consequently, founders who aren’t adept at business or who lack superior presentation skills may not get the opportunity to advance further. I’ve noticed that deep tech founders, particularly those from research backgrounds, often fall victim to this bias. This is unfortunate, as it not only results in missed opportunities for investors but also exacerbates the challenges these founders face. However, this situation can present valuable opportunities for the right type of investors and founders, as they can authentically appreciate and value each other’s input and specialities.

Jeremy Giffon from Tiny shared his approach to special situation investing on “Invest Like the Best”. The key takeaway for investors is to question why good deals come their way. Without a satisfactory answer, there is often something that remains undisclosed.

4. The Power Imbalance Shifts After Investment

Another less known but common observation is that investors have maximum power before investments are made, and almost no power afterward. Most founders have constructive relationships with their investors, but there are also founders who are noticeably ‘different’ after receiving the investments.

This brings us back to the earlier point around due diligence - it’s best to clarify all your concerns during the due diligence phase rather than wishfully thinking that founders will sort things out after receiving the funds.

5. Execution > Everything Else

For early-stage start-ups raising their first round of external capital, they usually have little to no revenue. Moreover, there’s a strong bias in the Australian start-up ecosystem toward betting on the founders. This creates a twisted situation where charismatic founders with big reputations have an easier time raising capital compared to less polished founders.

While it might still be early for me to assert this, my preliminary observation is that founders from big-name tech companies don’t necessarily have what it takes to build start-ups, and less polished founders might actually be running very good start-ups, especially in deep tech where you can’t due diligence the science.

Strong execution skills backed by traction are almost always the best ex-ante predictors for ex-post momentum. A start-up could be solving a real and painful problem, with a star-studded team and board, yet still fail to deliver. The shiny part might actually be what accelerates their death given the significant cost overheads.

Two other factors to consider are the amount of ‘fake progress’ mentioned and whether the north star metrics used are vanity metrics. Fake progress is fairly common, especially for first-time founders, as they tend to want to share good news to please investors and are unwilling to face the real traction because making actual progress is hard. This can include award-winning, talks with big companies, spending a lot of time networking with VCs, etc. Vanity metrics usually go hand in hand with fake progress. If founders don’t face reality, they won’t be able to change it.

The best founders I’ve backed tend to be really hungry and even undignified. Despite knowing about their impressive backgrounds during the due diligence stage, I’ve never once seen these prestigious names mentioned again in any of the investor updates. One of them can be said to be ruthless in execution - he literally talked to customers all day through all channels he could grab, rather than spending time to worry about looking good. It was uncool and definitely not glamorous, but it worked.

6. Syndicate if You Could

This is the lesson that struck me the most. The advantages of syndicate investing compared to solo investing are just too good to pass up. For one, it makes due diligence a lot more thorough and enjoyable, since you have multiple perspectives to consider. This also makes it more efficient for founders, who only need to answer questions once.

For two, it makes negotiation a lot easier, given the significantly increased bargaining power that comes with size. This leads to more reasonable terms for investors. However, the reverse is true if you're a single angel in a large VC-led round where you'll almost certainly be squashed in the negotiation.

Finally, there's a much bigger network you can tap into for the benefit of your portfolio companies. I’ve seen this happen firsthand, where the power of networks leads to introductions and opportunities that wouldn’t have been possible for solo investors.

Keep in mind, a lot of the syndicates out there aren’t really syndicates - they are deal-by-deal VC funds by nature where you need to pay 2/20. Technically the syndicate lead should’ve done all the work for you so your participation is optional. It might be nice to feel involved but I tend to avoid those as it is totally different criteria to evaluate VC investments as a LP.

Conclusion

In conclusion, my journey as an angel investor has been enlightening, revealing the less glamorous but incredibly instructive side of the start-up ecosystem. The insights I’ve gained have reshaped my investment approach and philosophy. Here’s to the continuing journey, to more learning, and hopefully, to more successful investments.