Can a successful entrepreneur become an equally impactful investor?
An entrepreneur's growth can be studied from various perspectives – their ability to scale up a venture, capture an industry, pave the way for innovation, etc. However, few entrepreneurs can also don the investor's hat and fewer can create a strong angel network.
Michael Volker is one such entrepreneur-turned-investor who decided to collaborate with other entrepreneurs and play an active role in building other companies. After selling his first company, Volker-Craig Ltd, Michael built WUTIF (Western Universities Technology Innovation Fund) to support early-stage tech companies. Michael also serves as the President of VANTEC, one of the biggest angel investment community in British Columbia. At VANTEC, he is helping other angel investors grow their portfolios and make better decisions. In this blog, we summarize the lessons he learned as an investor for the last 25 years, which are noteworthy for entrepreneurs, too.
Portfolio Size Matters: Aim for 40+ Investments
An important lesson for angel investors new to the community is to invest with a long-term vision and build a sizeable portfolio. The extensive portfolio size helps spread risk and allows investing in several high-performing early-stage companies that can offset losses from less successful ventures.
Rob Wiltbank's groundbreaking research on angel investing, conducted over 15 years ago, revealed a crucial insight: investors need a substantial portfolio to achieve optimal returns. Specifically, Wiltbank found that angel investors needed to invest in well over 40 companies to attain an average Internal Rate of Return (IRR) of 27%. This impressive return is challenging to achieve in most investment classes, highlighting the potential of angel investing when done at scale.
For aspiring angel investors, this research underscores the importance of diversification and commitment to building a sizable investment portfolio over time. Rather than putting all eggs in one basket, successful angel investing requires a strategic approach of spreading investments across numerous promising startups.
Focus on IRR, Not Just ROI: The Key to Evaluating Angel Investments
When evaluating potential angel investments, it's crucial to look beyond simple Return on Investment (ROI) figures and focus on the Internal Rate of Return (IRR). While entrepreneurs often claim impressive-sounding multiples like "8x in 10 years," these figures can be misleading.
The true measure of an investment's performance lies in its annual rate of return, which allows for meaningful comparisons with other asset classes. An 8x return over a decade might sound appealing, but it translates to an IRR of about 23% - respectable but not necessarily exceptional in the high-risk world of angel investing.
By focusing on IRR, investors can better assess the time value of money and compare opportunities across different ventures. This approach provides a more nuanced and accurate picture of potential returns, enabling angels to make informed investment decisions and build stronger portfolios.
Aim Higher: Why 30x is the New 10x in Angel Investing
In the world of angel investing, the promise of a 10x return has long been the gold standard. However, savvy investors are now setting their sights higher. As an angel, you should seek opportunities that offer at least a 30x return on enterprise value. Why? Because the reality is that 10x is often not truly 10x when it comes to your actual returns.
Consider this scenario: You invest at a $5 million valuation, and the company exits at $50 million. On paper, that's a 10x increase. But in practice, your return will likely be significantly less. Factors like dilution from multiple funding rounds, option exercises, and other financial events can substantially erode your share of the pie. By aiming for companies with 30x potential, you're giving yourself a better chance of achieving that coveted 10x return on your investment, even after accounting for these factors.
Leverage Liquidation Preferences to Mitigate Risk
In the high-stakes world of angel investing, securing a liquidation preference can be a game-changer, especially when dealing with inflated valuations. This strategy became particularly relevant in 2022 when pre-revenue startups commanded eye-watering valuations of $5-15 million. For angel investors, negotiating a liquidation preference is a crucial safety net, ensuring that you'll recoup your initial investment, plus potentially more, before other shareholders in the event of an exit.
This approach effectively mitigates the risk associated with investing at high valuations. By guaranteeing a return of capital (and often a premium on top), you're protected from scenarios where the company sells for less than expected. It's a powerful tool that allows angels to participate in potentially lucrative deals while maintaining downside protection. As you navigate investment negotiations, remember that a well-structured liquidation preference can significantly enhance your risk-reward profile.
Secure Information Rights as an Angel Investor
Obtaining timely and accurate information from portfolio companies can be challenging for angel investors, especially after the initial investment. However, there are strategies to ensure you receive the necessary data to evaluate your investments.
One effective approach is to leverage audit waivers. Many startups seek to waive their annual financial audit requirement to save time and money. As an angel investor, you can use this to your advantage. By law, companies must conduct annual financial audits unless unanimously waived by all shareholders. When asked to waive the audit requirement, you can negotiate for regular financial updates and information access. For instance, you might propose a compromise: "I'll waive the audit if you provide me with quarterly financial statements and key performance metrics." This creates a mutually beneficial arrangement that helps you stay informed without imposing undue burdens on the company.
By proactively securing and enforcing your information rights, you can better monitor your investments and make informed decisions about future funding rounds or exit opportunities. This diligence protects your investment and strengthens your relationship with the companies you support.
Cash Flow is Critical For Sustainable Success
Many startups, especially those led by first-time entrepreneurs, often underestimate the importance of cash flow management. They might focus on growth, product development, or customer acquisition, but without proper attention to cash flow, even the most promising ventures can quickly get into trouble. As an investor, it's your responsibility to ensure that the companies you back are innovative and financially prudent.
When considering an investment, don't just look at the current cash position. While a company must have adequate cash in the bank, you need to think beyond the immediate future. Before you write that first check, ask the tough questions about their long-term financial strategy. What are their plans for future funding rounds? Where do they expect that money to come from? How do they intend to secure it?
These questions aren't just about satisfying your curiosity; they're about assessing the financial acumen and foresight of the founding team. A solid answer to these questions demonstrates that entrepreneurs have a clear vision not just for their product or service but also for the financial journey of their company. If you don't get satisfactory answers, it might be wise to hold back and reconsider your investment.
Remember, as an angel investor, your role isn't just to provide capital; it's to ensure that the capital is used wisely and that the company has a sustainable path forward. By focusing on cash flow and encouraging your portfolio companies to do the same, you're not just protecting your investment – you're increasing the chances of success for everyone involved.
Know Your Partners: The Importance of Understanding Ownership Structure
As an investor, you should never hesitate to ask for the cap table of a company you're considering investing in or have already invested in. This information can be invaluable for several reasons. Firstly, if the company encounters difficulties, having access to the cap table allows you to quickly identify and potentially collaborate with other significant shareholders to suggest or implement necessary changes.
Moreover, particularly for those running a fund or an angel network, the cap table offers insight into the potential returns different investors might see in an exit scenario. This information can be crucial for understanding the dynamics of your investment and planning your strategy going forward.
Beyond these strategic advantages, having access to the cap table and share register can also provide you with a network of fellow investors to discuss your investment. This can be particularly useful for individual angel investors who might otherwise feel isolated in their investment decisions.
Surprisingly, many companies may try to claim that this information is confidential. However, it's essential to understand that you have a legal right to access this information as an investor. By statute, you can request and obtain the share register of any company you've invested in. While there might be a few procedural hoops to jump through, it's ultimately your right to have this information at your disposal.
About The Speaker
Michael Volker is a veteran entrepreneur and investor based in Vancouver, Canada. He is the Director of Simon Fraser University's Innovation Office and the CEO of WUTIF Capital, an angel investment fund. With over four decades of experience, Volker has founded several technology companies and actively supports startups through mentorship and investment.
You can watch his full keynote here.
