Things I wish someone had told me before I started angel investing

http://blog.rongarret.info/2017/07/things-i-wish-someone-had-told-me.html

by lisper • 9 years ago

602 204 9 years ago

blog.rongarret.info

brianwawok2• 9 years ago

I was hoping for a fact like

"And this is how I made 42 investments in my first 3 years. All are now bust, and I am out 1.4 million dollars"

Obviously not fun to tell the world how much money you lost, but it would help to add color to the people behind the VCs, that developers love to see as the frenemy (terrible people out to screw you, but man their money is nice sometimes).

lisper22• 9 years ago

Looking at what other people did and how that turned out is completely useless because the things that matter are the day-to-day details which you can only get by immersing yourself in the process full-time for a long time. So sharing that data would be worse than useless. At best it would serve to satisfy some prurient interests, and at worst it would cause someone to act on what cannot be anything other than hopelessly incomplete data.

But there is one detail I will share with you: I decided to start not in high tech because I thought it was too risky, but to get my feet wet by starting with less risky investments. So I decided to invest in a real estate development in 2006, thinking that even in a worst case scenario there's an asset there that will be worth something no matter how badly things go wrong.

Like I said in the OP, you will be shocked at how things can fail. (And this is far from my only horror story.)

FWIW, I've also had some winners along the way. I'm not poor, just poorER than I would have been if I'd just put the money in VTI.

jcousins• 9 years ago

With hindsight would you take the same path with your career and funds? I find myself at this crossroad right now, both financially and professionally, so found your article useful - thank you.

stevenj3• 9 years ago

Are most angel investors focused on finding the 1000x companies (i.e. the NBT) that VCs are?

I guess my question is what's a practical, good outcome for an angel investor when a company exits? Or what rate of return do the most successful angel investors have?

cakedoggie• 9 years ago

Like I said in the OP, you will be shocked at how things can fail. (And this is far from my only horror story.)

Did I miss the story, did you talk about it somewhere?

seibelj3• 9 years ago

My 2 cents - As an investor or potential employee when analyzing a startup, pay close attention to how scrappy and capital efficient they are. Do they have excessively nice office space? Are the founders making too much in salary? Does it seem like the executives are working like animals, or do they have the big company mindset where they take it easy? Startups are nothing like established, revenue-generating companies and the mindset should be entirely different.

The #1 thing a startup can do to survive is to be as stingy as possible with their capital.

azinman2• 9 years ago

It’s all a balance act. My last startup went bust in part due to the fact that we avoided hiring as long as possible in order to save money. In doing so we missed our inertia when we first started and we’re hot, and as we dragged on we didn’t have the diversity of talent to help do the things we were bad at (and didn’t want to do) ourselves.

Obviously super fancy offices, lavish meals, etc should be red flags, but you can’t generically say “be stingy” – it’s more like find the most efficient way to use your capital (which may include seemingly inefficient things that are actually required).

lordnacho• 9 years ago

My last startup went bust in part due to the fact that we avoided hiring as long as possible in order to save money.

While not going bust, I had a similar experience. In the early stages, you think you can do everything yourself, and you can. Network, hardware, software back and front, systems, the lot.

So once we had a little success I found it very hard to get my cofounders to spend a bit of money on some relief. Ended up paying up for some guy who wasn't compatible, and let him go soon after, which soured their taste for hiring entirely.

throwaway2048• 9 years ago

When you see startups blow millions a year on AWS spend because its "easy", when you could do the same on dedicated hardware for 1/10th or even 1/100th the price, it always shocks me.

Yes, queue the comments about "Total cost of ownership", past the point where you cant afford an OPs person(s) (which you will eventually need for AWS anyways) AWS is a money-sucking black hole.

LoSboccacc2• 9 years ago

For RDB? Sure. For EC2? Depends on many factors. Storage per safe, backed up and versioned gigabyte? Can't see anyone competing there.

eropple• 9 years ago

It's not about the hardware. It's about what happens when it breaks--which it will--and when you need stuff you can't reliably build off the top of your head--which you will.

The axe you're grinding is profoundly weird, and indeed a large part of my business is because the stuff we build is extremely cost-competitive with dedicated hardware. Difference being that I can open up the console and start shooting servers and nothing breaks. You're not saying the same with the overwhelming majority of naive "dedicated hardware" deploys, especially at the levels of skill and expenditure that small companies can employ.

nasalgoat• 9 years ago

I am a huge proponent of self-hosting, but there's other considerations when it comes to doing something like cloud - namely, CAPEX vs OPEX (Capital Expense vs. Operating Expense).

Having your own equipment is a CAPEX and investors don't like to see those on a balance sheet at all due to various accounting reasons. Mostly its seen as a burden. Cloud is an OPEX and investors seem to prefer renting to owning.

Personally I don't understand why spending 3x more is more attractive to investors, but often the technical reason being right is superseded by the business logic.

srtjstjsj12• 9 years ago

https://www.recode.net/2017/2/2/14492026/snap-ipo-2-billion-...

qaq• 9 years ago

Are any of those things issues at Angel stage?

endymi0n• 9 years ago

It's pretty much the same issue as with FizzBuzz: You'd be completely shocked at the insane ratio of people passing already the very basic smoke tests of good due diligence.

TheAceOfHearts• 9 years ago

Surely you can succeed without working like an animal? You probably can't take it easy like with a larger established company, but it doesn't mean you have to run yourself to into the ground in order to be successful.

seibelj3• 9 years ago

Normal employees should work hard but not ridiculous amounts. Executives, whose compensation is highly tied to stock value, should be animals, at least in the early pre-revenue stages. That is my opinion.

LoSboccacc2• 9 years ago

Most ideas don't exist in a vacuum and until you get your name associated with your market you're running the risk of someone faster stealing the buyers' hearts.

sabalaba• 9 years ago

The game of international capitalism is one where if you aren't working both smart and hard then somebody else is going to eat your lunch and leave your company's corpse on the side of the road.

edoceo• 9 years ago

Lean, not stingy. It's about reducing waste. I'm on my third company, stingy would kill us, waste would kill us. But, gotta buy the things you gotta buy, when you gotta buy them. Critical difference between Lean and stingy. Maybe frugal is the right word.

ScottBurson5• 9 years ago

gotta buy the things you gotta buy, when you gotta buy them

I would add, I think it's usually best to wait until the need is crystal clear. "We think we're going to need this in a few months" is not generally a good reason to spend money now, even if the case seems airtight. Circumstances can change. Of course the exception is when the purchase is needed to start a chain of events that you need to initiate, even though it won't come to fruition for a while.

rficcaglia3• 9 years ago

i have been lucky - multiple exits, 1 unicorn (and more importantly half a dozen fails)...and in that experience stingy always wins in hindsight. if it doesn't feel painfully stingy, be more stingy. the future You will thank you every single time, regardless of outcome.

dboreham• 9 years ago

Hahaha. Work like an animal for some guy who is semi-retired. Pass on that deal.

j2bax• 9 years ago

Do you have the money to fund it yourself? Do you have the network you need to greatly increase your chances of success at each stage? If so, definitely take that option. If not, the semi-retired guy isn't semi-retired because he gives his money to people that aren't highly motivated and hungry for success.

srtjstjsj12• 9 years ago

If you don't want to found a billion dollar company from scratch, you don't have to. Someone else will.

GreenPlastic• 9 years ago

I was part of a startup where the founders were older and the team was older. The technical competence and the competence of the team were amazing but I wouldn't characterize the team as "working like animals." However, the founders were pretty loaded and put in the initial 1-2M. We had a pretty good exit after less than 2 years.

CalChris• 9 years ago

I remember Ron although I was unsure about the name. Fair winds and following seas.

Unless it's in your background and in your DNA, it seems that angel investing will end in tears.

polote• 9 years ago

Summary: beginners almost never invest well.

And it is the same for stocks, many people think they will make money by investing in a specific company because their logic says it is good idea.

Investment is a job, and to win you need experience

FLUX-YOU• 9 years ago

And it is the same for stocks, many people think they will make money by investing in a specific company because their logic says it is good idea.

Probably like FizzBuzz, we'd probably be shocked at the amount of people that wouldn't default to lazy-3 or an index fund based portfolio.

I don't know of a good metric someone should study fundamentals before they'd be considered "ready" to invest in individual companies or options.

eru• 9 years ago

Depends on what kind of investment. If you want to win, but don't care how, just buy a broad index.

jacques_chester• 9 years ago

Summary: beginners almost never invest well.

Investing in startups is closer to betting on horse races than stuff like the S&P 500 or buying bonds.

There're a lot of people who will sell you systems. There's a lot of form guides. In a booming economy more people take a flutter on the fillies. And every once a while a thoroughbred emerges that is simply unstoppable.

But in general, only the bookies win.

The main difference is that in horse racing you can bet on a single horse and in the course of a few races, you'll probably bet correctly and make a little scratch.

In startups you can only bet the trifecta: you'll probably never hit it in your entire life, but the payoff is much higher if you do.

the_cat_kittles• 9 years ago

and, must like gambling, the winnings are very skewed towards the top small percentile. so, even if you know more than 90% of participants, you will probably get owned.

erikb3• 9 years ago

This blog post is also showing, however, that it is possible to make experiences without learning much. He doesn't seem to have figured out how it works, because that part is still rather unclear in his text.

trevyn4• 9 years ago

There are a myriad ways to make a company fail, but only two ways to make one succeed. One of those is to make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition. That is incredibly hard to do. (I'll leave figuring out the second one as an exercise.)

Is he implying some sort of unethical behavior as the second way?

lisper22• 9 years ago

Yes.

[UPDATE: before you downvote this answer you should know that I am the OP.]

trevyn4• 9 years ago

Something specific, or just unethical behavior in general?

erikb3• 9 years ago

Oh, I have totally missed that part. Happy to see that you didn't lose the money without learning something.

What decision have you made? Howling with the wolves or getting back to being a sheep? I'm still unclear in this part and actually hoped for some suggestions in one or the other direction.

beambot• 9 years ago

My immediate thought was more along the lines of companies that were built for acquisition -- either for the team or a technology (without business model).

gt_2• 9 years ago

Good point. I've only spent a limited amount of time in startup space but it seems this intention is usually considered more as a possible path rather than an intention. It's a common accusation but seems outlandish and unnecessary to me.

If anyone thinks this is wrong, please say so. I'm interested.

gt_2• 9 years ago

My guess is the second consists of pretending to do the first, so 'dishonesty'.

nsx147• 9 years ago

timing?

CodeWriter23• 9 years ago

It's the "do something illegal that people really want, then force politicians to rewrite laws or face the ire of their constituents" business model. Not sure if that's unethical or bold. When it comes to taxi laws, I view the laws as unethical, and challenging them as bold. OTOH, I see hotel laws as providing a necessary constraint on the cost of housing.

It worked as the foundation for several now big startups, but was the perhaps ethical breaking of said rules some kind of gateway drug to unethical behavior? Kinda looks that way in Uber and AirBNB's case.

And then again breaking perceived rules, ideas like Big Oil will be here forever or you have to be a defense firm to get a rocket launch contract, is bold and lucrative (or apparently future-lucrative). There is a fine line between bold and foolish.

mindcrime3• 9 years ago

One of those is to make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition

That's note quite true. You might choose to compete on, say, price, but that certainly isn't required. Likewise, you don't necessarily have to have a better product, if you are so much more operationally efficient that you can sell you product cheaper than the competition. It would be better to say that you need to be better than your competition in some combination of "better, faster and/or cheaper".

For more on this topic, I recommend The Discipline of Market Leaders by Fred Wiersema and Michael Treacy.

geetfun• 9 years ago

Being a good investor takes a certain kind of temperament. Can't really teach this. For most, as Buffet says, stick with the index fund.

TheBlerch• 9 years ago

The author makes good points here. While it's true that YC and other venture investors invest in many companies to increase the chances of large returns on the best of their portfolio companies, there is another significant advantage to YC having a bunch of companies in each batch - the teams that are not doing so well are a source of talent for the teams that are doing well. At some point YC can and has encouraged teams they think aren't making enough progress to join teams that are. A friend in one batch described his batch consisting of: 1/3 working on great ideas/products that could be big, 1/3 working on mediocre ideas/products and 1/3 working on bad ideas/products, and those in the bottom 1/3-2/3 still had good team members that could be sourced for talent for the best 1/3 and for previous YC companies doing well.

dkarapetyan• 9 years ago

The YC network effect is the secret sauce. Most YC companies would not even be able to bootstrap if it wasn't for YC alums like AirBnB.

tstyle• 9 years ago

Definitely. For an organization that spent a decade teaching startup the importance of building moats, it's no surprise that they've built their own.

Top192• 9 years ago

This is a really interesting point about YC. I've heard before that in markets some companies need to fail, their talent and assets act as "fertilizer" for helping the other companies grow.

joshjje• 9 years ago

That's how STARS are born!

Mz• 9 years ago

YC also basically does a lot of training, mentoring, etc. I don't know how much of that most angel investors provide. But YC is not merely rolling the dice. They are also doing a lot of weeding, watering, making introductions, sharing wisdom, etc.

So, pro tip: If you want to successfully invest, treat it like gardening rather than gambling.

banku_brougham2• 9 years ago

TLDR; you will lose money because you don't know anything.

rficcaglia3• 9 years ago

you can make money when you dont know anything.

correlation vs causation

you only always make money on 2/20 :o

banku_brougham2• 9 years ago

Not an endorsement or evaluation, was simply summarizing the article. The tone was my way to indicate my disappointment with an article that failed to life up to the headline. For someone with years of experience he/she didnt share any of the details that would have made this interesting.

lowercase_• 9 years ago

Interesting perspective, but he assumes that everyone's experience will be his own. First of all, he was in LA. I don't know of many success angels down there.

flylib• 9 years ago

"If you want to make money angel investing, you really have to treat it as a full time job, not because it makes you more likely to pick the winners, but because it makes it more likely that the winners will pick you."

plenty of good entrepreneurs have great angel investing track records doing it part time (Elad Gil, David Sacks, Aaron Levie)

logicallee5• 9 years ago

The investor names only "one way" to succeed (though alluding to a second one that this investor does not name):

To make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition.

This is an insane sentence. Let's make it only slightly more insane to throw it into starker relief:

To make a product that fills a heretofore unmet market need that nobody has expressed or even thought about until the company announces it, and to do it absolutely perfectly, instantly without any development time, and make it free for the consumer, while getting money from a sustainable high-margin source and having a proprietary moat that makes it impossible for any other market players to enter even a similar market. Also I'll add that the company must have such strong network effect that the utility of any competitor's product is negative (people would regret getting it even for free) unless the competitor is able to get at least 98% market share.

That's pretty insane, and if you re-read what I quoted you will see it's the same kind of insanity.

Why do people even write stuff like this.

EDIT:

Downvoters don't understand my objection. I'm not going to edit this comment. If you don't get it, you don't get it. This investor literally named "good, fast, cheap" (except as: better, faster, cheaper) as three of four requirements that must be met. (The fourth named requirement being "heretofore unmet".) You cannot get more insane than this except in magical la-la land where there are no trade-offs of any kind. It's absurd.

sidlls• 9 years ago

It's not only a bit silly (I wouldn't say "insane"), it's trite even if it were true. It's the tech wold equivalent of "folksy wisdom" about working hard. There's sort of a truism about it, but it's not useful in the sense that anyone can use it meaningfully.

logicallee5• 9 years ago

It is introduced with the sentence "There are a myriad ways to make a company fail, but only two ways to make one succeed" (where the second is left as an exercise for the reader.)

This introductory sentence does not permit the writer to follow up with folksy and false bullshit. This is like my saying "there is only one way to prove that a function will return the correct output for all input", then naming that one way (wrongly, but unironically) as "copy it verbatim from a StackOverflow answer".

The reader deserves more. Writers don't have the liberty to spread such nonsense.

Edit: I finished reading the article. It is outlandishly wrong. It says "There is a small cadre of people who actually have what it takes to successfully build an NBT (next big thing), and experienced investors are pretty good at recognizing them."

This is demonstrably false: investors are demonstrably bad at recognizing these people, who often go through hundreds of rejections (because investors are bad at recognizing them) before building the next big thing.

Really, this article could hardly be more wrong.

You know less about investing and the world than before you read it.

On the other hand, you learn more about what an angel thinks is happening, so I guess it's a wash.

birken• 9 years ago

But the cool kids don't beg. The cool kids — the ones who really know what they're doing and have the best chances of succeeding — decide who they allow to invest in their companies.

The company I was an early employee of (that ended up being a "unicorn") was not a cool kid, and we certainly were begging people to invest both at the angel stage and (especially) the series A stage. And those people got a really really good return on their money.

This isn't to say there aren't valuable signals perhaps involving "cool kids" status, but there are a lot of diamonds in the rough.

I figured it would be more fun to be the beggee than the beggor for a change, and I was right about that.

As a much smaller time angel investor myself than the author, I'm still the beggor. You are only the beggee if you are writing 25k+ checks (and more like 50k-100k to really be the beggee). If you are writing 5k or 10k checks, you are going to be begging people to take your money, cool kids or not cool kids. So if you are looking to get into angel investing today without allocating 6-figure amounts to your hobby, I wouldn't advise doing it for ego reasons :)

lisper22• 9 years ago

we certainly were begging people to invest both at the angel stage and (especially) the series A stage.

Oh, sure, but angels typically don't lead series A.

And yes, finding needles in haystacks does happen. But for any founder who really has the knack, it only happens once :-)

morgante• 9 years ago

This isn't to say there aren't valuable signals perhaps involving "cool kids" status, but there are a lot of diamonds in the rough.

Yeah, it entirely depends on where you're positioned as an investor. If you have great deal flow, then you can limit yourself to cool kids. But if you're more obscure, it makes sense to seek a comparative advantage with undervalued companies.

arikr3• 9 years ago

OP didn't claim that the cool kids always succeed, or that the uncool kids never succeed.

Just that they have higher odds.

taeric• 9 years ago

And numbers backing the claim would help. A lot. I'm inclined to believe it is all a craps shot.

logicallee5• 9 years ago

the article-writer OP claimed "There is a small cadre of people who actually have what it takes to successfully build an NBT [next big thing], and experienced investors are pretty good at recognizing them." which is hilariously and demonstrably wrong.

we already have one person chime in with a counterexample (the person you replied to) and that is a very common experience. No, experienced investors are not pretty good at recognizing them. It's hilariously wrong to claim they are.

empath75• 9 years ago

How is it that a $10k check even gets a startup to take your call? That pays like one engineer for a month, if that. (Genuinely curious)

mojuba• 9 years ago

Considering that "cool kid" founders do engineering themselves and that they typically don't pay salary to themselves, 10k could cover their initial hosting or say hardware prototyping costs.

shykes• 9 years ago

In my experience founders taking a 5-10k check often do it as a favor to an advisor they like and who can't afford to invest more. Maybe the advisor helped them out in the past, or their personal brand or connection are relevant to the startup.

cbhl• 9 years ago

A $5k check will give a super-early-stage "startup" (two or three college kids) with no salaries and about $1000/month burn rate ("living expenses" in the right market outside of SV) about four months of runway. You'd have to approach at a sufficiently early stage (like so: http://velocity.uwaterloo.ca/funding/velocity-fund/).

soham• 9 years ago

There are usually several of these $10K ones, especially from angels the founders like and want to have a longer term relationships with. Also, most initial development is either outsourced or done by the founders.

mstaoru• 9 years ago

Or it pays one skilled non-tech employee for a YEAR here in China. I'd gladly take $10k in exchange for 0.5-1% at this stage.

brianwawok2• 9 years ago

Group investment clubs. Get a group of 20 guys each putting 10k in and you get 200k. These exist in B.F. Indiana so they must be elsewhere too.

z3t4• 9 years ago

For someone who needs to support a family and with a fancy office it's nothing. But for some kids in a garage it will come a long way.

diegoperini• 9 years ago

10k pays for ten months of an engineer in Turkey and many developing countries.

warcher• 9 years ago

It's either part of the entire round, or it's gonna go to a founder, one of whom is an engineer if it's a tech biz, and it'll feed them for 2-3 months while they get the prototype together.

stevenj3• 9 years ago

Interesting read.

I'd love to hear from other angel investors with (perhaps) different experiences and opinions.

rficcaglia3• 9 years ago

my experience is that good deals are only available/viable/mutually beneficial when you have direct personal, close connections (please stop sending LinkedIn messages!) to the team. "retail" investing doesn't succeed in this arena.

my opinion is that you should only invest as a lone/lead angel in what you know from your long history in a super niche space where you know all the important cognoscenti from a career full of personal interactions...anything else is a guaranteed loss. fine if you use it as the OP says to learn about a market. though would be better IMO to just volunteer to work at a startup in a new area and learn by doing...which I have done and found highly educational and ultimately rewarding.

david9273• 9 years ago

There is a small cadre of people who actually have what it takes to successfully build an NBT, and experienced investors are pretty good at recognizing them. Because of this, they don't have trouble raising money.

That's a pretty specious statement. I don't know how he came up with that; it certainly doesn't match with a lot of reality.

haburka• 9 years ago

Just because you have a different experience than the writer doesn't mean that either experience is invalid.

lisper22• 9 years ago

I don't know how he came up with that

By looking at history. If you look lists of the most valuable startups the vast majority of them didn't have any trouble raising money. In fact, I can only think of a single recent (last 10 years) counterexample.

burrows2• 9 years ago

Alternatively, this just shows that it's hard to build the NBT without funding.

dabei• 9 years ago

Seems to me acting as a lone Angel investor is not very efficient and quite limiting to the kinds of opportunities that are open to you. It's analogous to the constraints you face with as a lone founder of a startup. Maybe better to team up and benefit from each other's insight and capital. And totally agree you have to do this seriously as a job unless you don't care about the money.

sgroppino• 9 years ago

Perhaps the key is to invest in what you know?

ted_dunning2• 9 years ago

Not if you want to get in on the NEXT new thing. By definition, you don't know that.

untangle• 9 years ago

Cap table economics are an equally-important reason to fear angel investing. Unless the company is very successful, angels tend to get diluted-out of the money by VC rounds. In the baseball vernacular, angel investors must pick triples and homeruns to make money. Singles and outs will result in total loss. Doubles may break even. It's a tough way to get ahead. Impossible without some insider edge (YC, pundits, stars, etc.).

sophiamstg• 9 years ago

I think I must agree with you on taking it as a full-time job!

mindcrime3• 9 years ago

There is a small cadre of people who actually have what it takes to successfully build an NBT, and experienced investors are pretty good at recognizing them.

I really do question this. The "problem of induction"[1] comes into play when you start talking about pattern matching and learning from "experience". That is, there's no guarantee that the future will look like the past.

Before Zuckerberg was Zuckerberg, I wonder how many people would have said "Hey, I recognize in this kid the innate capacity to be an NBT"? Of course they got funded, but I believe most of it was after they already had demonstrable traction.

On that note, one of the things that makes fund-raising such a drag, is that so many angels (at least in this area) want to see "traction" before investing. Even though, typically, you would thing that angels are investing at such an early stage that nobody would really have traction yet. Maybe it's just that the angels here on the East Coast are more risk averse.

[1] https://plato.stanford.edu/entries/induction-problem/

ScottBurson5• 9 years ago

I recall seeing a comment by Paul Graham somewhere to the effect that Zuckerberg set off his "founder detector" very strongly. This was after Zuckerberg was successful, admittedly, but it at least gives some suggestion that someone skilled at recognizing founders would have seen his potential.

TheCowboy• 9 years ago

Unless you saw something else, he was making a joke about having his own biases, not that he could identify Zuckerberg due to keen founder detection instincts:

And Graham knew that he had his own biases. “I can be tricked by anyone who looks like Mark Zuckerberg. There was a guy once who we funded who was terrible. I said: ‘How could he be bad? He looks like Zuckerberg!’ ”

http://www.paulgraham.com/tricked.html

dharmon• 9 years ago

It wasn't a comment on HN, but during an interview (video) he did with MZ on YC. I don't have a link, but that may help.

Zuckerburg was telling a story of how he built a "social" website to share notes for an art history class, except he didn't have any notes himself but got everyone to share theirs so he could pass his exam. This supposedly was an early experience that started him thinking about social websites and sharing online.

PG then commented how his internal alarm was going off saying "fund him. Fund him", and how even though it was too late he can't shut off his brains instinct to sniff out good founders.

austenallred• 9 years ago

Well Sean Parker and Peter Thiel seem to have picked up on it in the very early days. Not to mention the fact that the two biggest/best VC funds co-investing for the first time, letting them take money off the table.

It's fair to say those weren't average reactions.

prostoalex• 9 years ago

Every successful company will have a list of early investors. But not only is the list of those successful investors inconsistent (some startups were backed by Founders Fund, some by Sequoia, some by KLCB, some by Benchmark), the list of companies within the portfolio of a single investor (Founders Fund, to pick your example) is far from being 100% homeruns.

nikanj• 9 years ago

There's tons of companies like Clinkle, where the founder literally and figuratively looked just like Zuckerberg. Looking the part doesn't guarantee success, but it often does guarantee a few huge rounds of funding, at very impressive valuations.

srtjstjsj12• 9 years ago

Clinkle got $25million before they even built a product, from the tsunami of money raining down all over Silicon Valley post-Facebook IPO. Very different from Facebook which actually had traction.

acjohnson55• 9 years ago

I totally agree. In not so many words, the author explained how implicit bias works. It's not so different from the processes that shape the incoming classes of prestigious universities.

Want to know why these people can be recognized by experienced investors? At least part of the reason is that they know who looks like an NBT builder to other experienced investors. I would assert that this makes a massive difference in a founder's ability to close rounds and continue executing.

JamesBarney• 9 years ago

And also memory is very tricky. I imagine there are lots of people who met Zuckerberg thought he didn't have it took, but now believe they always thought we was going to succeed. That's why I suggest angel investors write down everything they thought about an encounter with someone immediately after the meeting. Why you think they'd succeed and fail? Then when you follow them in the future you can compare your notes to what happened and learn. Otherwise it's really easy for your brain to put together a completely unrealistic view of what happened in the past based on what's happened since.

mdpopescu• 9 years ago

I remember an article where someone said they were doing this in the Army, writing / saying "this guy has the potential to be great" or "this guy will wash out quickly", and discovering 20 years later that their predictions had no relationship to reality. (Can't find that article anymore though.)

srtjstjsj12• 9 years ago

In Facebook's amazing case, Zuck got $500K from Thiel almost immediately out of the gate, after a little traction and a bunch of backstabbing as to who at Harvard college controlled the company.

rwmj• 9 years ago

I wonder how often VCs/angels are conned out of money (and I don't mean by delusional entrepreneurs, but by genuine con-artists). I assume it must happen, and with all the money sloshing around may be common.

slackingoff2017• 9 years ago

I would say it's extremely common. Fake it till you make it is almost expected. Even the cons don't think they're lying.

I'm of the opinion that a lot of VC's are like money managers. Index funds regularly beat their returns but that doesn't stop them from think they're God's Gift.

VC's seem to be much the same. There's a lot of "black magic" to the funding process. In my experience, something that can't be logically understood usually has no logic behind it. Some of the VC's probably have real metrics but it becomes statistically impossible to find success using logic when you only fund a handful of companies a year. There's not enough data.

majani• 9 years ago

I think the most common instance is the middle ground, where an entrepreneur can clearly see systemic issues with his/her company, but still raises funds to keep the gravy train going.

danieltillett2• 9 years ago

While the points Ron raises are really good, there is another source of investing error which is "generals fighting the last war" effect. As an Angel investor you are drawn towards founders and companies that resemble you and your experiences. This is almost certainly going to lead you astray as conditions will have changed and everyone's experiences are so limited.

lisper22• 9 years ago

I was actually thinking of mentioning this, but there is a very strong counter-example: Google. One of the reasons Google went unnoticed for as long as it did (both Excite and Yahoo passed on opportunities to buy it for <1M) was that everyone thought that the search engine market was mature.

In fact, I think this is one of the reasons so many people are trying to re-invent Facebook. If Google could re-invent Excite and Facebook could re-invent MySpace (and Reddit could re-invent Digg) then why can't someone re-invent Facebook? And maybe someone can. (I sure hope so!)

danieltillett2• 9 years ago

Actually the "fighting the last war” effect was the reason everyone passed on Google. Almost all the VCs (and other companies) thought the search war and been fought and won five years before. Rather than looking at Google from an unbiased viewpoint (that Google was the first to solve search), they saw it as the 17th competitor in a mature market.

I think the difference with Facebook is the network effect and that it is run by Zuckerberg. What ever failings Mark has a CEO he has one amazing strength which is a single minded focus to let no competitor to Facebook rise. As he has shown time and time again he will buy you out or outspend if you have any possibility of being a competitor.

graycat6• 9 years ago

Good news: I can agree with some of the OP.

Much better news: I do believe that it's fairly obvious that there are good solutions to the most important problem mentioned in the OP.

First a remark on scope: I'm talking about information technology (IT) startups based heavily on Moore's law, the Internet, other related hardware, available infrastructure software, etc., and I'm not talking about bio-medical technology which I suspect is quite different.

Second, a remark on methodology: When the OP says "almost certainly" and similar statements about probability, sure, (A) in practice he might be quite correct but (B), still the statement is nearly always just irrelevant.

Why irrelevant? Because what matters is not the probability, say, estimated across all or nearly all the population, or all of business, or all of startups, or even all of IT startups. Instead, what is important, really crucial, really close to sufficient for accurate investment decision making, is the conditional probability given what else we know. When the probability is quite low, still the conditional probability -- of success or failure -- given suitable additional events, can be quite high, thus, giving accurate decision making. So, net, what's key is not the probability but what else is known so that the conditional probability of the event we are trying to evaluate, project success or failure, given what else we know is quite high.

So, back to the OP. We can start with the statement:

The absolute minimum to play the game even once is about $5-10k, and if that's all you have then you will almost certainly lose it.

Here for the "almost certainly" to be true needs to depend on what else is known. Sure, if not much more is known, then "almost certainly lose it" is correct. But with enough more known, the first investment can still likely be a big success.

The big, huge point, first investment or 101, is what else is known.

There is a small cadre of people who actually have what it takes to successfully build an NBT, and experienced investors are pretty good at recognizing them.

I agree with the first but not with the second. From all I can see, there is hardly a single IT investor in the US who knows more than even dip squat about how to evaluate an IT investment. E.g., commonly the investors were history or economics majors and got MBA degrees. Since I've been a prof in an MBA program, I have to conclude that a history or economics major with an MBA has no start at all evaluating IT projects.

Here is huge point:

We can outline a simple recipe in just three steps for success as an IT startup:

(1) Find a problem where the first good or a much better solution will be enough nearly to guarantee a great business, e.g., the next big thing.

(2) For the first good or much better solution, exploit IT. Also exploit original research in high quality, at least partly original, pure/applied mathematics. Why math? Because the IT solution will be manipulating data; all data manipulations are necessarily mathematically something; for more powerful manipulations for more valuable results, by far the best approach is to proceed mathematically, right, typically with original work based on some advanced pure/applied math prerequisites.

(3) Write the corresponding software, get publicity, go live, get users/customers, get revenue, and grow the revenue to a significant business.

So, right: Step (2) is a bottleneck: The fraction of IT entrepreneurs who can do the math research is tiny. The fraction of startup investors who could do an evaluation of that research or even competently direct such an evaluation is so small as to be essentially zero.

So, net, the investors in IT are condemned to miss the power of step (2) and, thus, flounder around in nearly hopeless mud wrestling in a swamp of disasters. And, net, that's much of why angel investors lose money.

So, the main problem in the OP was losing money on IT projects. The main solution, as both an investor and an entrepreneur, is to proceed as in steps (1)-(3).

For IT venture capitalists (VCs), they can't use step (2) either, e.g., can't do such work, can't evaluate such work, and can't even competently direct evaluations of such work, but they have a partial solution: Likely enforced by their LPs, in evaluating projects they concentrate on cases of traction and want it to be significantly high and growing rapidly.

So, with this traction criterion, and some additional judgment and luck, some of the VCs get good return on investment (RoI), but they are condemned to miss out on step (2).

So, what is the power of step (2)? As we will see right away, clearly it's fantastic: Clearly with step (2) we can do world changing projects relatively quickly with relatively low risk.

The easiest examples to see of the power of step (2) are from the US DoD for US national security. Some of the best examples are the Manhattan Project, the SR-71, GPS, the M1A1 tank, and laser guided rockets and bombs, all relatively low risk projects with world changing results. Each of these projects, and many more, was heavily dependent on step (2) and met a military version of steps (1) and (3).

More generally, lots of people and parts of our society are quite good at evaluating work such as in step (2) and proposals for such work, just on paper. We can commonly find such people as professors in our best research universities and editors of leading journals of original research in the more mathematical fields.

I started some risky projects, e.g., an applied math Ph.D. from one of the world's best research universities. From some good history, only about one in 15 entering students successfully completes such a program. The completion rate of applied math Ph.D. programs makes the Navy Seals and the Army Rangers look like fuzzy, bunny play time. With much of my Ph.D. program at risk, I took on a research project. Two weeks later I had a good solution, with some surprising results, quite publishable. Later I did publish in a good journal. I could have used that for my Ph.D. research, but I had another project I'd pursued independently in my first summer -- did the original research then, in six weeks. The rest of that work was routine and my dissertation. While working part time, the Navy wanted an evaluation of the survivability of the US SSBN fleet under a special scenario of global nuclear war limited to sea, all in two weeks. I did the original applied math and computing, passed a severe technical review, and was done in the two weeks. Later I took on a project to improve on some of our work in AI for detection of problems never seen before in server farms and networks. In two days I had the main ideas, and a few weeks later I had prototype software, nice results on both real and simulated data, and a paper that was publishable -- and was published. My work made the AI work look silly; it was. Once in a software house, we were in a competitive bidding situation. I looked at what the engineers wanted and saw some flaws. Mostly on my own, I took out a week, got good on the J. Tukey work in power spectral estimation, wrote some software, and showed the engineers how to measure power spectra and how to generate stochastic process sample paths with that power spectrum. As a result, my company won sole source on the contract. So, before I did these projects, they all were risky, but I completed all of them without difficulty.

Lesson: Under some circumstances, it's possible to complete such risky projects, given the circumstances, with low risk.

But IT VCs can't evaluate the risk before the projects are attacked or even evaluate the results after the projects are successfully done. So IT VCs fall back on traction.

I confess: It appears that the IT VCs are not missing out on a lot of really successful projects. Well, there aren't many IT startups following steps (1)-(3).

So, for IT success, just borrow from what the US military has done with steps (1)-(3).

The problem and the opportunity is that nearly no IT entrepreneurs and nearly no IT investors are able to work effectively with steps (1)-(3), especially with step (2).

The IT VCs have another problem: The know that for the next big thing -- Microsoft, Apple, Cisco, Google, Facebook -- they are looking for something exceptional. And they know that those for examples have very little significant in common. Still the IT VCs look for patterns for hot topics at the present or recent past. That's no way to find the desired exceptional projects. E.g., when the US DoD wanted the Manhattan Project, they didn't go to the best bomb designers of the previous 20 years; doing so would not have resulted in the two atomic bombs that ended WWII. Instead, the US DoD listened to Einstein, Szilard, Wigner, Fermi, Teller, etc., none of whom had any experience in bomb design.

lisper22• 9 years ago

We can outline a simple recipe in just three steps for success as an IT startup:

You might as well put a sticker on your forehead that says, "SUCKER."

Four of my investments (including a startup of my own) were absolute slam-dunks according to your process: large, well-established markets, orders of magnitude price-performance improvement over the competition, good IP protection. They all failed.

Like I said: unless you are very, very lucky, you will be absolutely be shocked by the creative ways the universe will come up with to screw you.

graycat6• 9 years ago

Fill us in; why did they fail?

I've seen a lot in business, and I never saw anything as challenging and perverse as your "creative ways the universe will come up with to screw you".

The worst I heard of was law suits by patent trolls.

For "secret sauce" in IT, that's in software locked up in the internals in a secure server farm. Tough to know just what is in that. Tough to get a judge to force you to present all your software to some troll without a lot of good reason.

There can be collusion in restraint of trade, but that's much harder to do now than 100 years ago.

There can be nuisance law suits, but the usual response is that those are too much work and trouble if the defendant is small and too little chance of winning if the defendant is big enough to defend themselves.

I saw a lot of how FedEx grew; some Teamsters were angry, but all they wanted was the usual, just money. Your statement of the perverse universe was not the case at FedEx.

I've seen some families do well with life style businesses. They commonly had problems, e.g., union problems, but they didn't have anything line your perverse universe claims.

Somehow I doubt that IT startups will have union problems anything like what was common in some old US businesses and industries some decades ago.

Nelson69• 9 years ago

So fundamentally as an angel you're in early. That usually means that you face dilution. I also wouldn't think it would be that unusual for the business to make a pretty dramatic pivot or two and that initial angel investment may have been for something else entirely by the time the company finds its legs. There are basically 3 things you can do in that dilution situation: 1) Do nothing and go from basically owning the business to not. (You still get to watch and be part of the ride) 2) Pony up more money to match the big investors, assuming the terms allow it, or 3) Fight it or any change every step of the way.

A VC once told me that there were "good angels and bad angels" Too many bad ones and he wouldn't invest. A couple specific bad ones and he wouldn't invest. To that, there are also good angels that will make introductions, spend time coaching, and really help beyond what I'd call a "hobby." It seems like there are good people out there with money and knowledge and they really want to help out others in an angelic sort of way knowing full well they will likely lose their investment.

mysterypie• 9 years ago

As an angel you're in early. That usually means that you face dilution.

I've always wondered why early investors don't include an anti-dilution clause in the contract? It could be structured in many ways, but it could be simple as "my share of the company will always be 18% (or whatever), no matter what, until I sell". Then when the company takes on more investment, it'll be up to the new investors and the company's accountants to do whatever share adjustments to keep you at 18%.

There must be some really good reason(s) why this isn't done and I hoping someone can explain.

snarf21• 9 years ago

If you are going to take on follow up money someone is going to get diluted. So where is it going to be? Squash the founders until they have no upside? Then why would they stay? When the money is this early, it has to be the existing investors. Some come in on the next round for a smaller number to keep their percentage fixed.

From working in a lot of very early stage companies, the two things I have seen is that some of these angels don't understand that the 10K they put in will probably need two more fundings of the same size before things get to an A round. Also, too much funding isn't tied to the right kind of metrics from the start. It is mostly about being cool and disruptive with no plan for the early customer and measuring everything from the beginning to truly know the health of the startup. ymmv

sjbase• 9 years ago

Makes it much harder to raise future financing, which is bad for everyone.

A company who has given away equity with anti-dilution is much less attractive for a new investor. If 30% of the company is allocated on anti-dilution, that means everyone else without anti-dilution is fighting for the remaining 70%. ALL future dilution comes out of their share. It acts like a dilutive multiplier.

So any new investor is going to want anti-dilution also. But there's only ever 100 percent. So you end up with new investors trying to force old investors to sell (or tasking the founders/board with doing so). This is not uncommon in reality.

BTW, most anti-dilution works by allowing existing investors the option to put in more money with each new round. I.e. they can "top off" their equity to X%, but only by investing more. So as an angel, you might have invested $100k for a few points, but to stay topped off in future rounds, you start having to invest a lot more as the valuation goes up. Not everyone has the desire or liquidity to do that.

srtjstjsj12• 9 years ago

Why should you get free money from later investors?

Theodores• 9 years ago

I prefer the phrase philanthropy to angel investing. As I understand it philanthropy is using your own hard earned money for lost causes of one's own choosing. This is different to fundraising or giving money to charity. With a modest philanthropy budget you can change lives and be able to support others achieve their dreams. Everything can be on an individual basis with no formal framework. For instance, what happens if you pay someone's way so they can finish their degree? What is the potential return? Or, more radically, what happens if you find a homeless person a place to live? Do they get a job and return to society? These things can be found out with radical personal philanthropy. I would say there is good value in this if you do want to learn about society and the human condition. I also think that financial and time losses are an investment. This type of work where you really do invest in individuals should help anyone angel investing to have the chops to do it well.

srtjstjsj12• 9 years ago

Yes, a failed business is called a hobby.

RandyRanderson• 9 years ago

It's impossible, with any certainty, for an investor to prove that his or her judgement is better than random chance. This is high schools stats.

What I take from this is that this person doesn't have a grasp if high school math or is not being honest.

Also if you listen closely to a lot of investors they'll basically tell you their metric is "can I sell this to a greater fool?". This is why there is so much investment in 'hot' areas when, in reality, those are the areas to stay away from as the unicorn shares are likely already over-priced.

justinsb• 9 years ago

Ron was one of our investors in FathomDB, and that turned out to be a bad financial investment, much to my personal dismay & regret.

However, something that I think the essay modestly overlooks is the non-financial elements. The investors made a huge difference in my life & that of the others that worked for FathomDB. I like to think that we moved the industry forward a little bit in terms of thinking about modular services (vs a monolithic platform-as-a-service) although it turned out that the spoils went mostly to the cloud vendors. Many of the ideas developed live on in open-source today.

Of course, this all serves Ron's point in that it doesn't make for a good investment. But that doesn't mean that no good came of it - and it makes me want to work harder next time so that it is both a good outcome and a good investment.

So: thank you to Ron and all our investors. It is no accident that you are called angels.

Radim• 9 years ago

Off-topic, but lisper, congrats on your neat HN karma points!

  It's 222-2222
  I gotta answering machine that can talk to you

kumarvvr• 9 years ago

The author has mentioned "random shit that markets do, like completely ignore clearly superior products..."

Can anyone give me such examples?? I am curious.

ddebernardy• 9 years ago

Betamax (vs VHS) comes to mind. As does Microsoft (vs Apple).

Prices played a critical role in both examples, but one can put forward that the product was evidently superior than the alternative that ultimately prevailed.

c1utch1• 9 years ago

Most obvious example is when an enterprise software / hardware startup will have superior product than bigco in their space. However, bigco sales & marketing budget and status quo stop the startup from gaining enough traction for success.

apeace• 9 years ago

There are a myriad ways to make a company fail, but only two ways to make one succeed. One of those is to make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition. That is incredibly hard to do. (I'll leave figuring out the second one as an exercise.)

Any guesses on the second way?

The best I could think of was: find dumb investors to pump it full of money and hype it. Then rely on all the hype to get it sold.

I'm hoping for a less cynical answer!

max_• 9 years ago

One of those is to make a product that fills a heretofore unmet market need, and to do it better, faster, and cheaper than the competition. That is incredibly hard to do. (I'll leave figuring out the second one as an exercise.)

Anyone figured this out?

caro_douglos• 9 years ago

This post reminds me of "the war of art" where you're encourage to make the decision right off the bat of whether or not you're a professional or an amateur.

I'm somewhat biased when it comes to angels because most of the experiences I heard (http://etl.stanford.edu/) were almost always homeruns. Sure there's the down in the gutter claims every investor tries to sob about where they lose money but let's be honest wouldn't it be great if someone gave a talk and said how much they lost (and how much they're continuing to lose) by attempting to get rich quick.

So far bootstrapping appears to best way of weeding out the shitty angels who haven't been in the game for a minute.....it's a pleasure to not deal with someone wanting to give you a check while telling you what their expectations are for YOUR business not their 10k+ check.

d--b• 9 years ago

I love the difference of tone between this article and the usual Silicon Valley pieces.

For me, the most important thing that Ron conveys is that being an entrepreneur is an incredibly foolish thing to do. Silicon Valley created myths of passionate geeks who worked in their mom's garages and went on to make billions. Who doesn't want that?

But the reality of Silicon Valley today is that because of these myths, most people work their twenties away for a chance to buy a lottery ticket...

PangurBan• 9 years ago

Thank you to the author for sharing your experience and insights. Some tips for being a better angel investor and reducing risk: 1) I can't stress this enough - learn the ABC's of private investments. I have seen a ridiculous number of angel investors as well as founders who don't understand the fundamentals of private equity investments and returns - even people who have been working at a startup for several years. 2) Limiting yourself to meeting with and investing in startups an industry in which you've worked, so that you understand their industry, better evaluate them and add value 3) Limiting yourself to meeting with and investing in startups in industries in which you or close colleagues and friends have worked so that you can consult with them regarding the potential investments 4) Joining an angel group, such as Band of Angels, so that you have a group of fellow angels to learn from and discuss investments with 5) Meeting with successful serial entrepreneurs who make angel investments to ask what they look for 6) If you have not founded a company or worked at an early stage startup, learn Lean Startup methodologies 7) Make sure you understand how a startup achieves product-market fit 8) Put together a list of good people and companies who can help startups you invest in, with everything from operations to tech to growth There's much more, but this is a start.

kushankpoddar• 9 years ago

I am realising that a weekly exercise on 'inversion' should be a must-do for founders/investors.

Inversion essentially means think hard about: "What factors can cause my venture to fail?, How to avoid those factors?"

This sounds simple but it could be a very powerful idea. https://www.farnamstreetblog.com/2013/10/inversion/

jonnathanson• 9 years ago

Every single word in this article burns clear and bright and true. Every word. Every paragraph. Every penny paid for every hard lesson learned.

If you want to get into the angel game in 2017, and you want to do it to make money, then I'd sincerely advise you to go take out $5-10k for a weekend in Vegas, and try to get really good at a game of complete chance, like roulette.

"Good" at roulette, you're thinking? What can that possibly mean?

It means having a large bankroll and knowing your tolerance for burning through it. It means understanding how to pace yourself, so that you're not blowing through your bankroll in the span of a few minutes. It means getting the itch out of your system, if, indeed, this is merely an itch.

Can't afford to fly to Vegas and blow 10 grand in a weekend? Don't get into angel investing. You can't afford it. I say this not as a snobby rich asshole, but rather, as the sort of nouveau-riche asshole who lost quite a bit of money many years back, doing exactly what the author did, and losing money I learned in retrospect I didn't really want to lose.

I still make the occasional investment, but as part of a group. By and large, those investments go to founders we've worked with before, or who come highly regarded. We invest super early, we eat a fuckton of risk, and we expect to lose 99.999% of the time. We're too small-time to play the game any other way at the moment.

Angel investing is about bankroll and access, and if you're wondering whether you've got the right access, you don't. So you're left with bankroll. Have fun, and try to get lucky if you can help it. :)

Top192• 9 years ago

Well written post, especially the first paragraph.

Thanks for using the term "nouveau riche". Don't know why, I haven't heard it since college, but made me laugh.

crispytx• 9 years ago

Yeah angel investing seems to be a wealthy mans game. You probably need to make at least 10 bets to have a chance at earning your money back. I did a little research and it looks like the first YC batch was comprised of 9 companies. Two of those companies, Reddit and Loopt, likely generated all the returns for that batch.

csense• 9 years ago

PG agrees you, he wrote a whole essay about the subject in 2012 [1]. At that point in time, he wrote that "just two companies, Dropbox and Airbnb, account for about three quarters of [YC's value]."

[1] http://www.paulgraham.com/swan.html

Things I wish someone had told me before I started angel investing

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