Since forming in 2009, Central Illinois Angels has learned—and adopted—best practices for angel investing.
Whenever you set out to start something new, it is often hard to imagine where you might end up—and what path you will take to get there. However, no matter the journey, there is both importance and value in taking time to reflect on how you got to where you are, what lessons you have learned, and how you can improve your performance going forward. That is certainly true when it comes to Central Illinois Angels, as we look at where we have come since starting as a fledgling group nearly eight years ago.
Like the early-stage companies in which it invests, the Angels started out with a “pitch” to potential new members and plans for success—though success is a broad term that can be defined in several ways, including financial return, mentoring opportunities, or simply learning from your peers and industry experts. And like the startups the group hears from, the Angels sought advice from industry experts, and even brought in seasoned investors to help its members learn best practices for angel investing. Looking back, many of these topics—which seemed foreign when first discussed—have now become lessons learned.
Bring Your 2×4
In some of our first education events, we had the pleasure of hearing from Bob Okabe. Although he offered a number of helpful insights, there is one that has stood out and become a very real lesson learned for us. He mentioned that he is sure to bring his “2×4” to every pitch he hears from early-stage companies. This meant he would apply the following logic to pitches from early-stage companies: take the information provided by the company and assume it will need twice as much time and four times as much funding. This logic, of course, was based on his own experience.
Given what our group has seen in the first eight years, the “2×4” approach, though not scientific by any means, certainly has merit. In our experience, companies (and investors) can very easily underestimate the amount of time it takes to gain traction in the market. With that added time comes the need for added resources, and in the case of investors, that is often in the form of additional funding. Although we do not always use the “2×4” analogy, it is a lesson that has been valuable for both our members and the companies we talk to and work with.
Keep Some in Reserves
As noted above, it can often take much longer for companies and their products to gain traction and begin to ramp their sales. It is then nearly inevitable that the company will need more funding—and they will be back to their prior investors in that additional funding process. That means investors need to make sure they keep another 35 to 50 percent of their original investment in reserve for any follow-on investments in which they plan to participate. Of course, not all follow-on funding is sought because sales are taking longer to materialize. Any number of investments may be tracking well and require additional capital for growth. Regardless, we can expect to be asked to participate in follow-on investments in our portfolio companies pretty regularly. In fact, most of the investments the group has made in the last 12 to 18 months have been of this nature.
Remember the 80/20 Rule
This is a critical lesson. On average, approximately 80 percent of investment returns for early-stage investors come from 20 percent (and oftentimes less) of the investments. Further, 2016 data from the Angel Resource Institute’s HALO report indicated that failures (exits at less than a 1x return) increased to 70 percent, which is up from 52 percent shown in a similar study in 2007. So far, our group has seen five of our 22 investments fail. Early-stage investors have to accept that failure will be a certainty for a majority of their investments. Be Patient… and Then Be More Patient
When the group first started, one of the “rules of thumb” was thought to be that companies would exit in a five- to seven-year timeframe. That meant investors could diversify their investments over that time and then begin reinvesting some returns within that five- to seven-year timeframe. However, recent articles and studies have shown the average time for the most successful exits is more in the nine- to 11-year timeframe, and to date, it looks like that will be the case for our group as well. This means our members have had to adjust their overall time horizons, and in some cases, it has led us to looking more closely at later-stage companies (those that would seem to be closer to an exit). Currently, several of our portfolio companies continue to track well, and we are hopeful that will translate into above-average returns.
Play Well With Others
Thankfully, we have learned that angel and early-stage investing does not seem to be a competitive sport. In fact, working with other investors is typically a welcome opportunity for several reasons. First, it provides the chance to seek additional input when it comes to the opportunity we may be evaluating. Second, it can bring in more funding for the company, as well as potential connections. Overall, it is a way to help with some diversification for companies in our portfolio, and it provides our group with a reciprocal relationship that can open new investment opportunities we might not have seen otherwise. In some cases, it allows us to introduce companies that might not be a good fit for our group to other investors in an attempt to help them be successful in their funding efforts.
Continuing Education is Invaluable
As is true with almost any business or industry, there is a lot to learn—not only from experience, but also from your peers. Over the years, we have hosted a number of education events. The most recent took place last fall when we had Dave Berkus share the numerous trends he sees materializing in technology, as well as the insights he has gained since he started angel investing some 20-plus years ago—including his admission that he missed the opportunity to invest in Amazon when it only had about 10 employees. It is important to understand the various trends in early-stage investment and look for ways we can become better investors, which in turn, should be a positive benefit for the companies in which we invest.
Looking back, we can see that we have made great strides since 2009. We have invested millions of dollars into 22 companies, and have certainly learned a lot along the way. We look forward to what lies ahead… and to continuing to take stock of our journey and how we can apply our past experiences to improve our future performance. iBi