Angel Investing: Add structure to improve returns on investment

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on January 22, 2018 - January 28, 2018.

What we have found over the years is that every so often, there is a company with really cool technology operating in a really hot market. But if that company does not have a unique value proposition, then you don’t have an investment opportunity. > Reichert

-A +A

Malaysian investors can improve their chances of making winning investments by applying a more structured selection criteria to potential investee companies and getting to know the founding team well, said the panel speakers at the Malaysian Business Angel Network (MBAN) Summit 2017 in December. 

During a panel session at the conference, Silicon Valley-based Garage Technology Ventures managing director Bill Reichert told angel investors to make an effort to understand what and who they are investing in. And one of the ways to do this is to develop a system they can use to evaluate potential investee companies.

Reichert, an early-stage technology venture capitalist, and his team, for example, have developed a scoring system that they use to analyse prospective companies. “This is a multi-variable scorecard that I have come to call ‘WTF’. Admittedly, it does not translate well into certain languages,” he quips. 

The ‘W’ stands for the two ‘U’s of unique value propositions and unfair advantages, ‘T’ stands for team, technology and traction while ‘F’ stands for financials. 

Reichert and his partners score these companies separately and then get together to compare findings to determine which of them are worth investing in — an exercise he says is crucial to maximising angel investments. 

For Reichert, using this combination of a scorecard and comparing findings with his partners is what helps them suss out genuine investment opportunities. Simply put, it prevents them from getting swept up in a compelling bit of technology that lacks any real world commercial applications. 

“What we have found over the years is that every so often, there is a company with really cool technology operating in a really hot market. But if that company does not have a unique value proposition, then you don’t have an investment opportunity,” says Reichert. 

Another panel speaker Chris Burry, the co-CEO of US Market Access Centre, points out that there are certain criteria that would automatically disqualify a potential angel investment. “First, do I have some level of domain knowledge on what the company is trying to do? For instance, if somebody comes to me with a really cool medical device, but I do not have domain knowledge, I would not be able to meaningfully contribute to any discussion of the investment, even within an angel group setting. Without that domain knowledge, I would probably not want to invest in the company. 

“Second, I would really want to look closely at the ‘origin story’ of the founding team. Out of the vast number of things these founders could be doing, why did they choose to found a start-up? If I get a non-committal or wishy-washy sort of answer, that would be an instant disqualification for me. 

“Being an entrepreneur is really difficult. You do not want to invest in an entrepreneur or company where the founder is not absolutely and deeply committed to the ideas.”

In addition to getting to know the company’s business plans and products, angel investors should familiarise themselves with the founding team of the potential investee company, says Burry. “When I am talking to entrepreneurs, I tend to do a lot of behavioural interviewing, which is a methodology by which you talk to people and see how they have behaved in past situations that would be relevant to the kind of personality trait you are trying to screen for.” 

He does this to identify just how coachable the founders are. “Angel investors should frequently communicate with their founders, offer them suggestions or question them about some part of their company to see how they respond. If they become very defensive and start to argue with you, that is usually not a good sign. You simply can’t nurture entrepreneurs who don’t want to be nurtured.” 

Burry advises angel investors to also consider if the investee company needs to take on a co-founder, assuming it does not already have one. “Data shows that early-stage companies that have co-founders tend to be twice as successful as companies with just one founder. Furthermore, companies with two co-founders — each with complementary skills such as a business and a tech specialist — are three to four times more successful than a solo founder,” he says.

“Your investee company founder needs to be willing to take on a co-founder if the need arises. And you as an angel investor need to observe the dynamic — the relationship should be that of two co-founders, as opposed to an employee-employer dynamic.

“The third and final qualifying step for me would be to run this start-up past other members of my angel group, or just with other angel investors whom I know. Because if only the founders can persuade me, and not the other angel investors, then I am probably not the one who is correct here.” 

Reichert says that given the diversity of opinions and expertise of an angel investing group, sometimes “being the smartest person in the room” is not always the best thing. “What we have discovered is that typically, the smartest person in the room on a given technology or sector tends to make bad decisions. That is because they have all this baggage about what it should be or used to be. But the reason you are investing in many of these companies is because they are doing unique and counterintuitive things.”

These start-ups are frequently changing all the established rules and people who are really well versed with the rules tend to be biased against disruptive companies. It is important for angel investors to take note of these unconscious biases they may have about sectors, technologies and even people,” says Reichert. 

Burry cautions against being a lone investor, explaining that angel investors should leverage the “wisdom of the crowd” more. “The data says that people who invest as part of angel groups have roughly twice the rate of returns than those who try to invest as individual angels,” he says. 

Reichert observes the lone angel investor trend in Malaysia, saying that a lack of collaboration and organisation among angel investors hurts their ability to spot winning start-ups to invest in.