Success factors of early stage venture investing

image What are the factors that determine the success of Angel investing?  In the most comprehensive study of Angel investors, Robert Wiltbank and Warren Boerker have looked at the portfolios and exits of 539  Angel led investments, in a three year study conducted through the Angel Capital Education Foundation and the Kaufman foundation (study is here Returns to Angel Investors in Groups).  They gathered data from several prominent angel networks including the Tech Coast Angels in Southern California.  Their analysis provides interesting insights into the factors that determine success in early-stage venture investing.

First, the numbers: the average ROI on investments of individual investors who are part of angel networks is 27% on average, with 2.6x return in 3.5 years.  The returns are concentrated in a small number of investments with only 7% yielding more than 10x.


1.  Due diligence: the amount of due diligence conducted on an investment is a direct predictor of success.  It is clear from the study that a higher number of hours of due diligence relate to greater returns on the investment.  This confirms that the large number of hours that angel networks spend in due diligence, per deal, is indeed time well spent.

2. Expertise: The experience of the angel investor in the industry that they invest in is also correlated with the success of the deal.  The strength of large angel networks lies in the depth and breadth of the expertise of its members.  This finding regarding the correlation of investor experience with returns indicates that in angel networks, investments are best led by (or actively supported by) members who have specific domain expertise in the area.


3. Follow-up: Hands-on investors had a higher success rate than those who were less involved with their portfolio companies.  This finding certainly makes sense, as companies that are closely mentored and receive the benefits of the investor’s experience, are more likely to succeed.


image The study covers investors in major angel networks.  Individual Angels are not included in the study.  It is not clear how the performance of individual Angels would compare with the results of this study.  One can only guess that single investors would not invest the tens to hundreds of hours of due diligence typically conducted on investments in angel networks.  On the other hand, angel investors with very strong know-how in a particular domain might perform very well if they invest within their own area of expertise.  Individual Angels tend to invest in companies and people that they are familiar with, so they might have more insight into the strengths and expertise of the entrepreneur. 

The issue of an investor keeping in close touch with the companies that they invest in, is a big one.  The standard recommendation is that an angel investor build up a portfolio 20 to 25 investments, so that they are properly diversified. For an individual investor (or even one within a network) the job of tracking that many companies can be very time consuming indeed.

And then there is the issue of what is "suitable diversification" in a venture portfolio. If we use the results of this study - that only 7% of investments are in the category of "make-the-fund" transactions that return more than 10x, it implies that in a portfolio containing the recommended 25 investments, 1.75 on average, will generate high returns.  With an error of 0.75 on the average number of investments needed, there is a 67% (1 sigma) probability that the investor get between one to two big hits under their belt. 

The last piece of analysis assumes a normal curve for venture investments. But but of course we know that there is nothing "normal" about venture investing, and that the highly interesting phenomena really lie in tails of the distribution!


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