Angel Investing Means Investing in People: How to Judge with Little Data

Due diligence in angel investing focuses on the person. VC and PE firms arrange more detailed due diligence and request due-diligence files from companies. Frankly, an angel investor's “due diligence” can be so simple as to be almost negligible. Suppose an entrepreneur has only an idea, has not registered a company, and has no team, but you are interested in investing. At that point, you are “betting on the person” in the right field. The only due diligence available may be talking to the founder's spouse to see whether they can offer unconditional support, talking to the parents about the founder's upbringing, or asking former colleagues. Even institutional angel investors considering an angel-round company that has operated for six months to a year cannot match VC due diligence in completeness or breadth. In fact, many companies that look outstanding today “would not have stood up to scrutiny” in their earliest days. Had angels devoted serious effort to due diligence, they might well have concluded, “We cannot invest,” “We dare not invest,” or “There is no way to invest.” For angels, it may be more meaningful to save that time and cost and instead share meals with founders and discuss their lives and aspirations. The defining characteristic of a startup and an inexperienced founder is “change”—evolution and growth with the times. The central idea of angel-round due diligence is to deepen your understanding of the entrepreneur. ----- Angel investing emphasizes returns more than the success rate. VC is also a game of probabilities, but places somewhat more emphasis on success rates than angel investing. PE pursues success rates even more strongly: almost no investment can be allowed to fail. This is because individual VC and PE investments are usually larger. These investors generally have operating data to inform their decisions and can manage risk. Angel investing differs because a newly started business has no data with which to judge the team's operating ability or the correctness of its direction. Nor can its valuation be reasonably assessed and calculated; most decisions rely on gut feeling. So-called “rational decisions” lack operating data, and “investing in people” does not involve the long observation needed to know someone's character. Conclusions often come from intuition over a short period. Applying VC methodology to angel investing may indeed raise the “success rate” and lower the “failure rate,” but it tends to require a majority of the investment committee to approve a deal. Most VC investment-committee members are seasoned veterans with some success in their respective fields, but they may lack sufficient sensitivity to new things. Such a committee and voting mechanism are highly likely to select unremarkable investments. The eventual result may be a higher success rate but substantially lower returns from the successful investments. Outstanding angel investments often return at least a thousand times the original investment, or even more than ten thousand times. #投資異類 (Touzi Yilei)