The last posts about the proportion of VentureSouth investors that have lost money in angel investing concluded that only a small minority (10%) of angels investing through our group have lost, or are on track to lose, money in aggregate.
That’s not a trivial number – we don’t want people losing money on investments made through VentureSouth – so we wanted to dig deeper to understand why those individuals received, or are facing, overall losses.
First, the obvious reasons:
startups fail all the time: the five-year survival rate of all new businesses, let alone technology startups in the Southeast, is under 50%.
50%-70% of individual angel investments result in a loss of some capital, according to the most authoritative academic data; the same is true for VC deals.
and in any dataset there will be “unlucky” investors in the left hand tail of the distribution and some “lucky” ones in the right hand tail.
But let’s dig further: what did those “unlucky” investors have in common, and what can we learn from their misfortune or mistakes?
First, diversification. It’s a cliché – but it’s true – that diversification reduces risk. Of the investors that fall into the “loss” category, around 60% (of the 10%) invested in only one or two companies. It is not really surprising, therefore, that they lost money. Startups are risky and individual companies frequently fail.
On the other end of the spectrum, only one of the unsuccessful investors made over ten investments, and that individual is on track (according to our best estimate of likely outcomes) to have a positive return in the end.
So, if you’re diversified, you stand a much better chance of not losing money. If your angel investment plan is “one and done,” or you expect to generate 20%+ annual rates of return from a couple of angel investments (alone or through any group), you will be disappointed. VentureSouth’s biggest strength is the opportunity to develop a portfolio of well-curated investments quickly. We’ll come back to that, and how diversification affects returns overall, another time.
Second, timing. Some of the loss-making investors have realized losses but still have paper gains that might result in a positive return overall; if their portfolios mature as we think, they would move out of the population. Fingers crossed – and noses to the grindstone.
These individuals highlight the inescapable reality of angel investing: angel are “blessed” with early failures and (usually) long-term gains. If a deal is going to fail, it is likely to do so quickly, as its 12-18 months of runway from the angel round are exhausted; if it’s going to win, you might enjoy an “early exit” – a solid result quickly, which is a good rate of return – but it will likely take 3-5 years or longer for truly successful results. A 10x return in two years is a rare exception – but we have those in our portfolio, and others do too.
So, the VentureSouth data supports what we tell members and potential members: angel investing is risky, but if you’re diversified and patient your probability of success is much greater.