“There are three ways to do early-stage investing,” Nelson Chu insightfully said.
I was meeting with three of the smartest investing minds I know: Nelson Chu, Graham Osborn, and Chris Dardaman. We were discussing Graham’s upcoming presentation to Angel Lounge at the ATDC. His topic was applying Peter Thiel’s Power Law of Venture Capital to angel investing.
Chris had a concern about this topic, “I don’t want this presentation to convince our group to stop investing in startups.” Given the way the majority of angels invest, the reason he said this was simple. The risk-reward does not look good. In fact, the numbers look downright dismal.
Then he asked me, “Why do you think our members invest in startups?”
“I believe they do it for a couple of reasons. One, it is a meaningful way to stay engaged in our community. Our members have lots of experience, and they want to help entrepreneurs be successful. Being around startups is fun. Two, they want to make money,” I said.
“But the odds of success are slim,” he pressed. “What kind of returns are they expecting?”
“To be honest with you, I think most of us would be happy simply getting our money back over time,” I said.
That’s when Nelson jumped in, “There are three possible investment strategies. I just read a Bloomberg article about an American who netted $1 billion in winnings by betting on horse racing in China. After reading this, the three possible models of early stage investing became clear to me.”
Nelson continued, “You can invest as a player. You can invest in people who invest in early stage companies by using an investment thesis which includes high involvement. You can invest like people who go to the race track or a casino.”
This is what I did. I was president of a national professional services business owned by a British public company. I had developed deep expertise, credibility, and network in this professional services area.
In the early nineties, the labor laws regarding non-competes allowed top managers who were working for software and professional services companies to jump ship and start their own company. In addition, ERP companies were growing 50-100% per year which created enormous demand for services. I rode this wave.
But I brought something to the table. Of course I had money and would fund these entrepreneurs. But I also brought encouragement and day-to-day guidance. I was on site as a player’s coach. I did this by building a professional services incubator. This allowed the entrepreneurs and me to be in the same office space.
I learned every day about their business and challenges. So much information was shared real time just by talking at the coffee bar in the office. This allowed meaningful and timely discussions on next possible steps to fix problems and to build the business.
I didn’t know any better at the time, but this was what Nelson calls the player’s strategy. It’s like betting on horse racing as a former trainer, jockey, or groomsman. They know the horses intimately and know the people who train, ride, and take care of the horses. This is a big insider’s edge to picking the winning horse.
This means investing in someone who has an investment thesis. This is Nelson’s territory. Kinetic Ventures is on its ninth venture fund. He and his partners got there by total daily involvement in selecting companies and helping them succeed in any way they can. This includes introducing them to large potential accounts and key employees, assisting in strategy, and connecting them to key advisors and accountability.
Kinetic has a clear investment thesis, and they remain disciplined to the thesis. They must do this as they are accountable to their limited partners. The fund must implement the strategy it proposed in the offering documents. And every partner must be working on the success of the fund every hour of every day. This is how they achieve or exceed the promised LP returns.
This investment strategy is akin to the American who earned a billion dollars in horse racing. I say he earned it rather than won it. If you read the article, you will see the amount of work he and his team of people put in to develop the winning betting strategy. Betting on horse racing became his business, and he was the best at it. He brought betting on horses down to a science.
This is where the great majority of angel investors reside. This is investing as an art rather than a science. We choose to make investments based on our experience and gut feel with minimal due diligence. We say things like, “I liked that guy,” or, “It feels like it could be a big business,” or, “I know people will buy their product.” Then we write a check.
My dad used to love going to the race track. He would take $500 with him and see if he could double or triple his money. He loved to study the racing form. He approached his bets by processing as much information as was available within the half hour between races. He looked at the last three workouts, the last three race times and finishes, whether or not the horse was a mudder, the dead weight the horse was to carry in the race, and so on. Then he made a decision and placed his bets.
If he won, it was a great day. If he lost, it was a good day. After all, he loved going to the race track and watching those magnificent animals run as hard as they could. He loved it.
This defines most angel investors, including me now.
Angel investing with the goal to build wealth requires the first or second strategy. Making investments without this insider knowledge or disciplined investment thesis is fun but not profitable.
When I started angel investing in 1993, I did it as a player and built wealth. Over the last five years, I’ve invested like the guy who goes to the racetrack for fun and excitement. If I get my money back on these most recent investments, I’ll call it a good day. It was fun, and I got to work with some really great entrepreneurs. If I make money, it will be a great day!