Challenges of Smaller Funds vs Being an Angel

As an angel investor, you can pretty much do whatever you want.  Angel returns in aggregate hover right around 27%.  VC returns are lower.  But, that too is aggregate and encompasses both funds that invest early and funds that only invest late.  My experience as an angel investor help me with what we are doing now.  The biggest difference is when angel investing, putting money in a company at a $4M pre-money and having it exit at $50M is okay as long as it’s not the only exit.  Angels need one company out of ten to hit 30x and they do really well.  Funds need to have that chance every time.

Why?

One reason is carry.  As an angel, you keep 100% of your carry.  As a fund, you split it with your LPs.  By the way, I am not complaining-LPs are taking a lot of risk too.  Another reason is that if you are doing a fund, you didn’t come to hit singles.  There is just too much risk in early stage investing to not swing for the fences.

When I traded, you could hit singles.  If I hit a bunch of singles I could make a pile of money.  The difference between trading and early stage investing is two-fold.  Time and liquidity.  Very often in trading, I had trades on for less than a minute.  Returns take between 5-10 years for early stage startups.  In trading, there was the ultimate in liquidity.  If I screwed up, I could get out.  Not so investing in companies.

As an angel and a small fund investor, you are pretty sensitive to how many rounds it will take to get to exit-and how much money it will take to get to exit.  Getting watered down on the cap table is a part of it.  The key is how fast will the company grow.  If the valuation of the company jumps fast enough, the dilution you take is okay as long as you have enough money in at the beginning.  If the company grows slowly and needs a lot of capital to get to where it needs to go, you are going to be dead in the water.

All that really changes your psychology as an investor.  Yes, you still bet on good people with good ideas.  But, you have to really think hard about returning money to investors.  Angels think about this, but most of them aren’t as disciplined about it.

  • awaldstein

    You are outlining a conundrum.

    Sure the cost of starting something is about nil.

    But the cost of market success has increased dramatically and in order to really make a difference or mark, consumer of enterprise, the actual costs will continue to rise.

    How that works to the small fund as you describe it I don’t know but exits without a rolling chunk of capital seems more and more unrealistic to me.

    • Man are you right about that. The cost of market success has really shot up in the past few years. I believe you and I noticed the increased cost of marketing despite “free” platforms a couple of years ago. The good news is those costs seem to be a lot more efficiently allocated because you can target better.

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