Note: none of the following is investment or money management advice. Talk to professionals about decisions you want to make!
I invest in startup companies with my time and money. This decision makes me an "angel investor." The usual definition is an individual who purchases equity in a startup company with their own money. Contrast this with a venture capitalist, who invests with other people's money - that of their customers or "limited partners."
Angel investors in the United States must be "qualified" or "accredited" - with some exceptions Qualified investors must pass one of three tests. First, they must have an income of over $200k (individual) or $300k (married couples). If not, they must have a net worth (assets minus liabilities) of over $1 million. And one can skip both of these tests by earning specific test-based qualifications for the management of securities. Of these, I see the income test, and net worth test met most often by angel investors. I know people who pass the knowledge test, but they tend already to meet one or both of the other two requirements.
These requirements are born from a tragic pre-SEC history of capitalism. The intent is to prevent fraudsters from scamming little old ladies out of their savings. A person with sufficient wealth is believed to be more sophisticated about money and can make more informed decisions on these riskier investments. This principle is also why cryptocurrency-related instruments are so controversial: they look more like sketchy securities from which the SEC exists to protect ordinary people.
So an angel investor needs to have some money - but not a super high amount. Crowdfunding is a way to get past even this requirement. In the United States, "regulation CF" permits accepting up to $5 million in equity financing through an accredited intermediary. Individuals, including those not "qualified," can write much smaller checks that go into a vehicle - a special fund - for managing that collective stake.
We often turn to angels early in developing a company because they can make decisions based on looser criteria than an institutional investor can. The first angel is the founder: trusting that time and personal resources spent on this project will be high-return. The second might be a close family member who wishes you to succeed. After that, there are friends and others who believe in your mission and capability.
I remember talking to a venture capitalist who referred to this kind of early money as the "three Fs": friends, family, and fools. The first two might invest because they like you and have inside knowledge about your capability. The "fools" are people without that inside track who lay their money with you anyway. In my experience, most good founders don't have "fools" on their list of shareholders.
It's my view that many founders treat all three "f"s as if they were the third. In other words, they do not treat their angel investors nearly well enough.
Why do people become angel investors in your business? In the vast majority of cases, because they believe in you. They put in their own hard-earned money to help fund your operation. These checks are far smaller than those from institutional investors, which makes them seem like smaller potatoes. But since it is their own money, it is a more significant slice of their wealth in most cases. Consider the person who earns $250k in salary and allocated $25k to your business. How meaningful is that allocation to them?
When I am considering who to invest in, I look at two kinds of inside information. One is the founder. Do I understand the founder and founding team better than others? I only invest in founders who I have known for at least a year. Seeing someone's behavior over a more extended period is an edge. The window gives much more opportunity to understand their character.
Second, I look at the market. Do I get the market better than the average bear? Do I see it as having great potential? Put a different way, do I wish I were starting a company in that space?
Assuming each of the above is true, does the founder understand this market better than I do? When all three questions align, I am willing - even eager - to discuss investing equity-ish money.
Notice that the product is not one of my criteria. I seek product-founder fit. I don't think the founder's idea is essential for my decision except that it should apply the entrepreneur to a good market with unfair odds.
The best investment relationships - the ones where I feel best-treated - are those where the founder communicates consistently and well with investors. Not to say they accept all of my feedback or advice. But they set expectations for moderately frequent updates - weekly or monthly, depending on the stage of the company - that update on progress and make us smarter.
It's this latter point that separates the greats. If the startup works out well, investors see a financial return. If the startup has trouble, the investors learn about that trouble with you and become better managers of time and money in the future. Sharing the insight learned about the market means the investor can't lose.
Further, sharing insights with the investment "team" lets you call upon their wisdom. The most exceptional founders I have worked with shine on this question. They consult with different investors - people who already have skin in the game - to get out of jams or make more significant decisions. These people want you to succeed and usually have some high-end skill for which they are paid well or have made their fortune: that's how they became qualified investors.
In my limited investing experience, this good relationship does not last forever. One of two things can happen. The business might get into doldrums where the founder is not sharing their status or lessons anymore. They find that most investors don't respond when they skip reports or send lower-quality ones. But the investors do notice. Specifically, I do. This degradation of information flow and slippage in trust might not have short-term impacts, but it will affect your relationships in the medium term.
Second, this relationship shifts when institutional money enters the picture. The angels' $25k or $50k investments collectively don't seem like such a big deal when a million-dollar (or more!) check is in the bank! Plus, these investors often require board seats and take on more active governance. The intervention of professional investors can lead to better standard reporting. This involvement might improve consistency, though these reports do not hit the information-rich highs of the early investor letters. I generally wish founders in these positions well since introducing the next level of capital indicates higher odds of a financial outcome.
But don't forget about them. Taking care of your early investors beyond a financial outcome is a great way to get them back for your next venture. And this is a matter of consistent, quality communication. The founder I backed in a previous startup - even one that did not generate positive returns - has a significant leg-up with me if they showed how well they treated me with information.
Many of the traits I described above feel very natural when we think about them as customer management. How do you treat early customers? You will find much of the same issues of consistency, information, and communication apply here too.
If you manage your early investors as customers - and your early customers as investors - you will build a virtuous cycle that lets you serve the markets for both your equity and your product.
Photo by Annie Spratt on Unsplash