Angel investor breakfast

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Badger1754
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Angel investor breakfast

Post by Badger1754 » Sun Apr 15, 2018 4:32 pm

I had breakfast this morning with a long-time family friend (and his son) who is a fairly accomplished angel investor. Over the past 20 years, his angel portfolio has delivered a ~30%+ return.

His son, on the other hand, is a dyed-in-the-wool Boglehead (he put his bar mitzvah money in VOO) and thinks his dad is nuts.

We had a fascinating discussion over his angel portfolio versus what his son (and I) tend to put our money into. Needless to say, he doesn’t subscribe to the Boglehead philosophy that you shouldn’t try to beat the market.

Where we landed (philosophically) was a place that explained both why he was able to generate excess returns and why Boglehead-style investing was right for the masses. Interested in feedback here to see if we missed anything.
  1. Liquidity. As an angel investor, he deals with very illiquid assets that do not trade and transact regularly. Moreover, he gets information through his angel network, which is not usually available publicly. As a result, there is a defined information advantage that doesn’t exist in public markets.
  2. Governance. As an angel investor, he has board seats (and sometimes chairmanships) at his portfolio companies. Therefore, he has a hand influencing management decisions and corporate strategy for the better. The excess returns he generates is therefore not just his information advantage, but his own managerial contributions.
  3. First mover advantage. Since he is seeding his own companies from scratch, he gets in at low valuation levels before much larger chunks of VC capital flood in, which drive up his valuation. Therefore his cost base is lower.
Therefore, by transacting in companies where little information is publicly known, providing active management oversight, and by being a first-mover — he can generate excess risk-adjusted returns over an extended period of time, because none of these advantages exist in the case of “active management” of public equities.

That being said, none of this makes sense for the masses because 1) most people don’t have $1-$2M laying around to seed their own angel portfolio, 2) most people don’t have the time to get involved in an angel network or participate in board governance of their angel portfolio, and 3) if you try to professionalize it as a fund to passive investors, the fund fees will eat up the excess returns.

UpperNwGuy
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Re: Angel investor breakfast

Post by UpperNwGuy » Sun Apr 15, 2018 4:43 pm

Seems to me that you would have to have some significant financial resources at your disposal to be an angel investor. That counts me out.

inbox788
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Re: Angel investor breakfast

Post by inbox788 » Sun Apr 15, 2018 5:01 pm

Badger1754 wrote:
Sun Apr 15, 2018 4:32 pm
[*]Governance. As an angel investor, he has board seats (and sometimes chairmanships) at his portfolio companies. Therefore, he has a hand influencing management decisions and corporate strategy for the better. The excess returns he generates is therefore not just his information advantage, but his own managerial contributions.
Is he paid for his involvement, particularly if he holds a seat on the board?

How many proposals does he screen before he lands on an investable idea? Is this somehow accounted for? Part of the hidden costs in active management that passive investors don't have.
if you try to professionalize it as a fund to passive investors, the fund fees will eat up the excess returns.
I didn't not understand this. Please elaborate.
UpperNwGuy wrote:
Sun Apr 15, 2018 4:43 pm
Seems to me that you would have to have some significant financial resources at your disposal to be an angel investor. That counts me out.
Technically, you have to be an accredited investor. Something I think I could pass, but never bothered because I didn't want the wolves knocking on my door. Practically, everyone knows some relative's friend who's staring their thing and needs investors. You could put together 3 or 4 digit investments from multiple investors and have a nice startup sum. The question is whether these businesses as an asset class are better than Total Market. They should be because they're higher risk, but I suspect often they're not. And more importantly, even if they were better investments, are the better after risk is adjusted?

How did that "30+%" return over 20 years get calculated and audited? If a gambler told you they regularly won money at the casino, would you believe them? Would you follow their lead or have them bet your money? Systems don't work, and card counters have to work a lot to make use of their skill. Anyway, I suspect there's some (unintentional) survivalship bias in that reported number unless proven otherwise.
Last edited by inbox788 on Sun Apr 15, 2018 5:10 pm, edited 1 time in total.

golfCaddy
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Re: Angel investor breakfast

Post by golfCaddy » Sun Apr 15, 2018 5:07 pm

That mostly covers it. A few counterpoints: even if you get in at a low valuation, you can be massively diluted by the time of an exit. See the Social Network for an extreme example. From memory, the research does find angel investing produces above market returns, but the dispersion of returns is enormous. Some of his excess return may be the inside information/activist investor alpha, but mostly it's probably dumb luck to be invited into the right deals. On a risk adjusted basis, you would probably be better off investing in a good VC fund, if you could theoretically get in as an individual.

inbox788
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Re: Angel investor breakfast

Post by inbox788 » Sun Apr 15, 2018 5:18 pm

golfCaddy wrote:
Sun Apr 15, 2018 5:07 pm
From memory, the research does find angel investing produces above market returns, but the dispersion of returns is enormous.
I haven't read anything about this, but I'd pay attention to the methods, samples and bias of any reports about return or lack there of. All situations are different and unique so fairly anecdotal and not repeatable IMO. Simply averaging different opportunities, people, situations, competitors, etc. isn't going to lead to same results the next rounds.

Why Angel Investors Don’t Make Money
https://techcrunch.com/2012/09/30/why-a ... ls-anyway/

Angel Investors Do Make Money
https://techcrunch.com/2012/10/13/angel ... s-overall/

Badger1754
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Re: Angel investor breakfast

Post by Badger1754 » Sun Apr 15, 2018 5:41 pm

inbox788 wrote:
Sun Apr 15, 2018 5:01 pm
Is he paid for his involvement, particularly if he holds a seat on the board?

How many proposals does he screen before he lands on an investable idea? Is this somehow accounted for? Part of the hidden costs in active management that passive investors don't have.
He is NOT paid (his portfolio companies are too small to be able to afford monitoring fees. However, you raise a good point in that he invests significant time and energy in screening and doing due diligence on his portfolio companies. If i were to put a dollar value on that, it would be enormous.
if you try to professionalize it as a fund to passive investors, the fund fees will eat up the excess returns.
I didn't not understand this. Please elaborate.
Precisely as above. If you try to set up a vehicle to allow outside investors to participate without the expecting their time and talents toward screening, diligence, monitoring, governance, and oversight — the fees the fund would have to charge would negate any excess return.
How did that "30+%" return over 20 years get calculated and audited? If a gambler told you they regularly won money at the casino, would you believe them? Would you follow their lead or have them bet your money? Systems don't work, and card counters have to work a lot to make use of their skill. Anyway, I suspect there's some (unintentional) survivalship bias in that reported number unless proven otherwise.
I have no way to audit that number, but he also has no reason to lie to me. For what it’s worth, I know a few of his exits were large enough to make news. Even if it were only 9% instead of 30%, he still would have generated an excess return over a consistent period of time.

garlandwhizzer
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Re: Angel investor breakfast

Post by garlandwhizzer » Sun Apr 15, 2018 9:43 pm

I know something about angel investing because I've done it in the past. It's as risky as things get, often an all or none proportion. It is very difficult to separate hype and dream from reality when you talk to those who this approach. I simply do not believe that an angel investor using this technique has successfully generated a 30+% compound annual return for 20+ years. At that rate your money doubles at least every 3.5 years, sooner if you're excess of 30%, so the portfolio has doubled eat least 6.5 times over. That means you start out with $20,000 and in 20 years you have $1,900,000+. That assumes the investor consistently picks winners and avoids losers, something that in practice is about as rare as hen's teeth. There are a few tech mavens who convert start-up sweat equity into massive cash when their firm goes public and get results like this or even much better. For every one that hits it big there are hundreds that fail completely. I agree with the angel investor's son on this one. Most who swing for the fences fail while those who consistently get singles reliably succeed in the long run.

Garland Whizzer

golfCaddy
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Re: Angel investor breakfast

Post by golfCaddy » Sun Apr 15, 2018 9:50 pm

There's also a big difference between a 30% continuously compounded return for 20 years and an IRR of 30%.

MathWizard
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Re: Angel investor breakfast

Post by MathWizard » Sun Apr 15, 2018 10:38 pm

Badger1754 wrote:
Sun Apr 15, 2018 4:32 pm
I had breakfast this morning with a long-time family friend (and his son) who is a fairly accomplished angel investor. Over the past 20 years, his angel portfolio has delivered a ~30%+ return.

His son, on the other hand, is a dyed-in-the-wool Boglehead (he put his bar mitzvah money in VOO) and thinks his dad is nuts.

We had a fascinating discussion over his angel portfolio versus what his son (and I) tend to put our money into. Needless to say, he doesn’t subscribe to the Boglehead philosophy that you shouldn’t try to beat the market.

Where we landed (philosophically) was a place that explained both why he was able to generate excess returns and why Boglehead-style investing was right for the masses. Interested in feedback here to see if we missed anything.
  1. Liquidity. As an angel investor, he deals with very illiquid assets that do not trade and transact regularly. Moreover, he gets information through his angel network, which is not usually available publicly. As a result, there is a defined information advantage that doesn’t exist in public markets.
  2. Governance. As an angel investor, he has board seats (and sometimes chairmanships) at his portfolio companies. Therefore, he has a hand influencing management decisions and corporate strategy for the better. The excess returns he generates is therefore not just his information advantage, but his own managerial contributions.
  3. First mover advantage. Since he is seeding his own companies from scratch, he gets in at low valuation levels before much larger chunks of VC capital flood in, which drive up his valuation. Therefore his cost base is lower.
Therefore, by transacting in companies where little information is publicly known, providing active management oversight, and by being a first-mover — he can generate excess risk-adjusted returns over an extended period of time, because none of these advantages exist in the case of “active management” of public equities.

That being said, none of this makes sense for the masses because 1) most people don’t have $1-$2M laying around to seed their own angel portfolio, 2) most people don’t have the time to get involved in an angel network or participate in board governance of their angel portfolio, and 3) if you try to professionalize it as a fund to passive investors, the fund fees will eat up the excess returns.
I have a brother who does this. He is also a business consultant.
He and others like him started profitable businesses first.

The value of an angel investor is not just the money, since any passive investment would do that.
The added value is the business experience, the way to determine how to develop the business into
one that makes a profit long-term, and to bring in additional long-term investors as needed. Most
angel investors take the business to a point where it is a less risky proposition where other investors
(not angel investors) will want to buy in. That may be an IPO, but is more often a private equity investment group
which hopes to make better than public market return on companies that are not under the same constraints
that a publicly traded company would be. These groups do to have the direct involvement with the company's
founders in the early days that an angel investor does.

Not all investments by an angel investor pan out. They need large returns to pay them for the misses and
for all the (very valuable) uncompensated experience that they bring.

quantAndHold
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Re: Angel investor breakfast

Post by quantAndHold » Mon Apr 16, 2018 1:38 am

Badger1754 wrote:
Sun Apr 15, 2018 5:41 pm
inbox788 wrote:
Sun Apr 15, 2018 5:01 pm
Is he paid for his involvement, particularly if he holds a seat on the board?

How many proposals does he screen before he lands on an investable idea? Is this somehow accounted for? Part of the hidden costs in active management that passive investors don't have.
He is NOT paid (his portfolio companies are too small to be able to afford monitoring fees. However, you raise a good point in that he invests significant time and energy in screening and doing due diligence on his portfolio companies. If i were to put a dollar value on that, it would be enormous.
if you try to professionalize it as a fund to passive investors, the fund fees will eat up the excess returns.
I didn't not understand this. Please elaborate.
Precisely as above. If you try to set up a vehicle to allow outside investors to participate without the expecting their time and talents toward screening, diligence, monitoring, governance, and oversight — the fees the fund would have to charge would negate any excess return.
How did that "30+%" return over 20 years get calculated and audited? If a gambler told you they regularly won money at the casino, would you believe them? Would you follow their lead or have them bet your money? Systems don't work, and card counters have to work a lot to make use of their skill. Anyway, I suspect there's some (unintentional) survivalship bias in that reported number unless proven otherwise.
I have no way to audit that number, but he also has no reason to lie to me. For what it’s worth, I know a few of his exits were large enough to make news. Even if it were only 9% instead of 30%, he still would have generated an excess return over a consistent period of time.
If he started with $1M, has been making a 30% return consistently for 20 years, he’d be worth 9 figures. Is he?

At 9%, it would be more like $5M.

AlohaJoe
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Re: Angel investor breakfast

Post by AlohaJoe » Mon Apr 16, 2018 1:50 am

inbox788 wrote:
Sun Apr 15, 2018 5:01 pm
Badger1754 wrote:
Sun Apr 15, 2018 4:32 pm
if you try to professionalize it as a fund to passive investors, the fund fees will eat up the excess returns.
I didn't not understand this. Please elaborate.
Not the OP but the way i'd read this: the literature is pretty clear that lots of active mutual funds, hedge funds, etc "beat the index" fairly regularly before fees. If you DIY then you are essentially paying those fees to yourself. Instead of thinking of it as "my angel investing return 30%" it might be more accurate to say "my angel investing returned 9% net of fees but I paid myself 2 & 20 as the active manager plus earned implicit directorship fees of $50,000 per year per company". I think there's also a bit of (suggestive but inconclusive AFAIK) evidence that funds can outperform when they are small but lose that when they get large and have a hard time figuring out how to invest their billions of AUM. As a DIY you avoid that kind of crowded trade issue.

runner540
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Re: Angel investor breakfast

Post by runner540 » Mon Apr 16, 2018 9:08 am

I hope that after discussing his 30% annual returns, he had the good manners to pick up the check! :D

Sounds like a full time job. And his Rate of return needs to include all the ones that went to $0.

For every deal you see, you have to ask "why me?" You have to understand clearly the reasons why that entrepreneur is showing the deal to you versus all the other investors, otherwise you'll have a selection bias problem.

GCD
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Re: Angel investor breakfast

Post by GCD » Mon Apr 16, 2018 6:26 pm

It seems like this has the same hidden problem of being a landlord. People sometimes talk about how much better their returns are for investing in real estate and being a landlord vs. investing in the stock market. But I can invest in an index fund for effectively zero effort. If I want to be a landlord that requires some level of effort. That makes it at least a part time job. If this guy is sitting on boards and being chairman of this and that then this is his job. That's a lot more effort than passive investing which you can do in addition to a job. One would hope he is seeing outsized returns since he is putting in a lot more effort than I am.

golfCaddy
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Re: Angel investor breakfast

Post by golfCaddy » Mon Apr 16, 2018 6:28 pm

30% is high, but not crazy if capacity is limited. Sitting on boards is time consuming, so maybe at any given point in time, he's invested in 5-10 deals. The typical raise in a seed round might be $1M. That raise might get distributed over 5 investors on average. Then, his cost basis at any given time might be $1M-$2M. It's possible he is seeing 30% returns on his angel deals, but those represent a fraction of his investment portfolio.

Dhchicago
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Re: Angel investor breakfast

Post by Dhchicago » Tue Apr 17, 2018 11:01 pm

This. I am involved in similar investing. Giant dispersion, high returns, quite private markets where reputation of investors defines who sees the goood deals, lots of angles for value add from investors.

None of this is inconsistent with efficiency or boglehead thinking, as the capacity is tiny. I work with a big group (over 50 people) that only manages to invest about $10m per year total, and that is gross before any exits. You cannot COMPOUND at 30 (for long) as others have pointed out, but you can generate quite high returns if you do it well and across a lot of reasonably good deals. This is NOT low maintenance so depending how you value your time you might also dispute the 30% number. But regardless it is interesting and fun.

livesoft
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Re: Angel investor breakfast

Post by livesoft » Wed Apr 18, 2018 6:21 am

Did this breakfast conversation cover about any of the failures and losses? I have found that usually they are much more interesting than the successes.
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Badger1754
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Re: Angel investor breakfast

Post by Badger1754 » Wed Apr 18, 2018 6:28 am

livesoft wrote:
Wed Apr 18, 2018 6:21 am
Did this breakfast conversation cover about any of the failures and losses? I have found that usually they are much more interesting than the successes.
Absolutely! The most painful failure for him was one where it was apparent it was going to go off a cliff BEFORE the seed round even closed (the seed round took much longer to close than anticipated). But because he was one of the organizers of the round, for reputational purposes he stayed in even though his investment was stillborn.

Badger1754
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Re: Angel investor breakfast

Post by Badger1754 » Wed Apr 18, 2018 6:29 am

Dhchicago wrote:
Tue Apr 17, 2018 11:01 pm
This. I am involved in similar investing. Giant dispersion, high returns, quite private markets where reputation of investors defines who sees the goood deals, lots of angles for value add from investors.

None of this is inconsistent with efficiency or boglehead thinking, as the capacity is tiny. I work with a big group (over 50 people) that only manages to invest about $10m per year total, and that is gross before any exits. You cannot COMPOUND at 30 (for long) as others have pointed out, but you can generate quite high returns if you do it well and across a lot of reasonably good deals. This is NOT low maintenance so depending how you value your time you might also dispute the 30% number. But regardless it is interesting and fun.
That is correct. He works with startups as part of his day job, but I think he spends close to 50% of his time in diligence, governance, developing his angel network, and other activities in his angel portfolio.

Badger1754
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Re: Angel investor breakfast

Post by Badger1754 » Wed Apr 18, 2018 6:31 am

quantAndHold wrote:
Mon Apr 16, 2018 1:38 am
If he started with $1M, has been making a 30% return consistently for 20 years, he’d be worth 9 figures. Is he?

At 9%, it would be more like $5M.
Let’s put it this way.. when he has to travel, he does go to Newark or LaGuardia or JFK. He goes to Teterboro.

downshiftme
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Re: Angel investor breakfast

Post by downshiftme » Wed Apr 18, 2018 4:50 pm

I also have a friend who was an active angel investor. Luckily he had plenty of money, so didn't need his angel investments to pay off. And they didn't. As a small time player in the angel investment space, deals that were offered to him had already been rejected by the bigger fish. That made them riskier and unless he could do a large number of them (he couldn't) or got very lucky with the deals he chose (he didn't) his long term returns were terrible. He treated it like a start-up company lottery, and he never did get a winning ticket. I think he was happy with the overall experience and he got to be an important person for w while at each company, plus he got some good cocktail party stories out of it. Financially it wasn't lucrative at all.

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