96% of all startups shutdown within 10 years of “starting-up.” Investing in early stage startups is a very risky business. Let this be a disclaimer for all those that want to enter this business seriously or for fun – be ready to go home empty-handed and red-faced. An angel investor or VC’s success can be attributed to several factors: understanding the space, the network, their own genius, diversification of portfolio and almost all the time – a good slice of luck.
The angel investor (or early stage VC) has the potential for generating a large amount of wealth in a short period. So let me be clear that this article does NOT provide gyaan on how to be successful at angel investing. This article is about whether you should participate in angel investing. Many developed countries define venture capital investors as sophisticated or accredited investors that have a significant net worth or who display enough knowledge to participate in this space. In fact, the US requires that you show at least $1 million (Rs 6.8 crore) in networth excluding the value of the primary home to participate to invest in startups.
So why is it important to build such credibility before entering such a risky space?
- There is a high probability of a complete loss.
- There is a chance that the startup does well (eventually) and you still don’t make good returns because of high dilution.
- You cannot exit the investment easily even if the startup is doing well.
- There are cases where founders have defrauded the company and investors.
I have personally requested the Start-Up India team to bring in regulations to control the unbridled entry of angel investors, some of whom are betting 30%, 40% and even 100% of their investment portfolio in investments into startups (sometimes even just ONE startup). The Startup India’s inability to regulate the industry (due to various valid reasons) does not mean that we shouldn’t self-regulate. If we don’t, we allow the entry of people who can wipe out their entire net worth and the industry will suffer due to the greed of a few founders and angel investment networks.
Here are some of my requests to the players in this space:
To the founders:
- Reject investments from individuals who do not investment a minimum of 5 lakhs (~$7500) as those with smaller amounts are most likely passive investors who will not follow-on in later rounds. )They are also a pain to follow up for tranche based payouts)
- If you are going to accept a Rs. 5 lakh cheque, the investor should bring in at least 10-15 lakhs worth of non-cash benefits.
- Keep the cap table clean with larger cheques from smaller group of investors instead of the opposite
To angel investment networks:
- Get your own accreditation standards to review the net worth of members and reject those that do not meet a net worth of Rs. 10 crores ($1.5 million).
- Charge a decent annual fee so that the cost of investing is high enough to attract larger cheques.
To the incoming investors I request that you:
- Limit your exposure to 10% of the TOTAL investment portfolio (i.e. your liquid net worth)
- Have a minimum investment outlay of 50 lakhs per year ($75000) for a minimum of 7 years
- Have the liquidity to double the amount from years 4-7 to invest in follow-on rounds.
The next time I get a request from someone to join the angel investment space I am forwarding them this link… Will you?