What Do Angel Investors Actually Do? (Part 1)

For a long time, I wondered what a day in the life of an angel investor looks like. How do investors and startups get introduced? What kind of information gets exchanged before and during meetings? How are decisions made? What happens after an investment? This post is an attempt to describe some of my recent experiences from the investor's perspective. This is not meant to be authoritative or comprehensive, but instead to provide a good high-level overview for those who are interested in startup investing.

At a high level, angel investors have handful of responsibilities:

  1. Find companies that look like good potential investments.
  2. Talk to said companies.
  3. Convince the more promising companies to take your money. (No, really.)
  4. Offer advice and introductions to existing investments.

I will cover the first two points in this post and last two points in the next post.

Looking for Prospective Investments

Okay, your business card says Angel Investor. Now what?

The first thing you need to do is to find companies to invest in. This is referred to as deal flow. If you don't have any potential deals to evaluate, then there's nothing for you to do.

So how do you find potential investments? There are many viable approaches:

  • Your personal network. Sometimes an investor and a startup founder have a mutual friend who introduces them at the appropriate time.
  • Other angel investors. For the purposes of investment diversification, angels typically invest much less than companies are looking to raise. For example, a typical angel might seek to invest $50k in 20 different companies, but each of those companies will be looking for $400k or $800k or some other amount that much higher than $50k. You might expect angel investors to be competing with each other, but this is only the case for the hottest startups. Most of the time, because no single angel investor can provide a startup with all of the funds it is looking for, investors will share their deal flow with their investor friends.
  • Demo Days. These days, a large number of startups go through startup incubators and accelerators like YCombinator or 500 Startups. These incubators provide a little bit of funding and a lot of advice and connections to their startups in exchange for a small amount of equity. The incubators also host Demo Days 1-3x per year where startups have a chance to showcase their accomplishments to potential investors.
  • Sites like AngelList. AngelList is a directory of startups, entrepreneurs, and investors. The site frequently features startups that are looking to raise money, and it's a great place to learn about what's new in the startup world.
  • TechCrunch, etc. Sites like TechCrunch, Mashable, and VentureBeat can be starting points for research. If you read an article about a product that you think is interesting, you can do a little research and if you're still impressed, you can contact the company to see if they're looking for funding.

Talking to Companies That Seem Promising

Great, it looks like you found a few companies that you'd like to talk to. What should you talk about? At a high level, the main goal of talking to a company is mutual understanding. The investor's goals are to understand the startup's mission, the problem that they're trying to solve and how they plan to solve it, who the competitors are, and so on. The startup's goal is to raise money (obviously), as well as to figure out if the investor is a good match: do they have the right connections? Are they a short-term investor or someone who's in it for the long haul? Do they have any valuable-industry specific knowledge or experience? Investments ideally happen when there's a good mutual fit between the investor and the startup.

Some specific things investors consider:

  • Understand the problem. What is the actual problem that the startup is trying to solve? Is the problem a huge pain or a minor nuisance? Does it affect most people, some people, or a small group of people? What do people currently do to solve this problem?
  • Understand the solution. How does the startup plan to solve the problem? Is their solution still just an idea, or do they have a prototype? If they have a prototype, have they gotten feedback on it and had a chance to improve it, or are they mostly guessing that it will address customers' needs?
  • Understand the economics. How will the startup make money? How will they attract customers? Is there a cost to acquiring each customer? How much will the product cost to develop and how much will it be sold for? Can it be sold at different prices to different segments of the market? Does the founding team have a financial goal, like selling the company for 20 million dollars to the first person who's interested, or do they hope to become a billion dollar company or die trying? What's the startup's current valuation* and what could its long term valuation potentially be?
  • Understand the competition. Who would the startup consider its competitors? If there are competitors, how does the startup plan to differentiate itself and is that differentiation strong enough? Does the startup have a strong competitive advantage that makes it hard for other competitors to catch up?
  • Understand the technical challenges. What are the biggest engineering challenges? Is the engineering team good enough to handle those challenges? How much of the product can be addressed with software and how much of it requires human input?
  • Understand the founders. What motivates them? Are they control freaks or are they looking for advice? Do they have a lot of experience in their startup's area of focus? Do they have a well-rounded skill set or are they lacking in a major area like product management or engineering? Did you hit it off well enough to want to work with them on-and-off for the next few years?
  • Understand the fit between the investor and the startup. Do they have the same long term goals? Does the startup fit the investor's thesis**? Does the investor have expertise or knowledge or connections that can help the startup?
    These questions are often answered over the course of several phone calls or meetings. Like an interview process, which might start with an HR phone screen and end with several hours of in-person grilling, each meeting is progressively more technical and intense, finally culminating in a decision of whether to go forward with the investment.

Next week, I'll discuss how and why investors sometimes have to convince startups to take their money, and what happens after an investment is made.

* A startup's valuation is what it claims to be worth. For example, if a startup is raising $1m at a valuation of $10m, then that means they're claiming to be worth $10m and are selling approximately 10% of the company for $1m. The valuation is typically determined through some combination of the strength of the founders, the current state of the product (idea vs. prototype vs. in production), current revenues (if any) and costs, projected revenues and costs, the size of the target market, optimism, and moxie. (Valuations are either reported as pre-money or post-money valuations. I don't want to get into the technical details, but if you want to understand the difference between the two, the Wikipedia article is quite good.)

** An investor's thesis is their investing philosophy. This might be something generic: "I invest in companies which have great founders with proven track records." It could also be very specific: "I believe the future of medical devices is the use of QR barcodes and RFID tags, and I invest in health startups that use those two technologies creatively."