My Search for an Investment Thesis

“You should not be investing in angel deals anymore. Your investor profile changes with age, and so do your investment goals. You should move from wealth building to preservation of capital and cash flow,” advised my wise friend David Adams of Adams Capital.

That was three years ago.

When he said this, I was 61, and I knew in my gut he was right. Since that time I have invested in five new deals, two follow-on investments, plus two VC funds. Making a life transition is very difficult. It is easier just to keep doing whatever it is I am doing than to change the rules on myself.

I’ve been a professional angel investor for close to 25 years. Investing in startup companies isn’t about a balanced investment portfolio for me. Investing in startups is my occupation. I love to work with entrepreneurs, and I love great investment returns. When I started in 1992, my goals were to generate cash flow and build wealth. To achieve these goals, I created a unique investment thesis.

My thesis: Invest very early stage as the lead investor and own 25% to 50% of the company.

I stuck to my investment thesis until three years ago. Instead of following David’s advice, I strayed from the discipline of my investment thesis. I say strayed as opposed to changed because I never really sat down and figured out the returns I could achieve investing the way I was now investing.

I began investing like the typical angel investor. It wasn’t quite like the adage of spraying and praying. No, I was more careful than that. I would size up the market opportunity combined with the integrity, commitment, and market experience of the entrepreneur.

So it was $25k here, $50k there, and so on.

Most of the investments were very early stage and were the dreaded convertible notes. Since I was putting in small amounts along with the other investors, the term sheets were dictated by the entrepreneur. Mind you, I was always advising against this type of angel investing, and now I found myself doing it.

I never understood how anyone could build wealth investing this way in early stage companies. Angels on the west coast are always talking about how this is the way to go. And because the west coast sets the standard, we angels in Atlanta and elsewhere simply adopted this methodology.

But I had a sneaking suspicion this would never work. I believed the west coast investors were making great returns because they happened upon a unicorn deal. A single unicorn deal, meaning a company which achieves a $1 billion valuation or more, changes everything. If I put $25k in a company valued at $3 million and it becomes valued at $1 billion, that’s a 1000% return!

This has yet to happen in Atlanta.

I made my money by investing significant capital in companies with a $500k valuation. If the company survived and later prospered, it would sell for between $5 and $30 million. I would own between 10% and 40% of the company depending on how much financing was needed to get the company to exit.

So here I was now investing like the typical angel investor. If I put $50k (assuming a $500k round) in a company valued at $3.5 million, then I own 1.25% of that company. If I assume there is an additional 50% dilution over time, and the company sells for $30 million, I make $187,500. This is 3.75 times my investment. Great. But maybe not so great. Let’s take a look.

How long will it take for the company to get to a reasonable exit valuation?

Probably seven to ten years. This means, in my example, I achieved a 14% to 20% internal rate of return on this investment. This looks pretty good, but not every investment succeeds. In fact, statistically, 6 in 10 investments return zero. Three give me my money back, and one will give me the above return. If I blend all my $50k investments together, I will have a portfolio internal rate of return between 0 and 4%. That’s a lot of risk for such a low return.

I talked to a friend of mine who is with a private equity company. He is much more of a quant than I will ever be. I told him the numbers and time frames I was talking about, and he agreed with my math. He then said, “But angel investors invest for other reasons beyond financial returns. They have a ‘why’ which supersedes investment returns.”

That’s the answer.

Prior to three years ago, I had a strong why but also had an investment thesis which provided for a great return. Investing as the typical angel invests means my why is way more important than my desired financial returns.

When David Adams and I talked over three years ago, he knew my investment thesis. He advised me to stop investing in startups. But I tricked him. I changed the way I invested. Now I realize he was right. I should not invest in startups at my age unless my why is so important to me I’m willing to lose money or realize meager returns.

I need to think about this.

What should my investment thesis be now given I still have a strong why?

 

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5 thoughts on “My Search for an Investment Thesis

  1. Charlie, I understand the dilemma that you were having in determining your investment future. MY aha moment re Angel Investing came in 2001. I had previously left Angel Investing for a short while, then I had two slam dunk deals. Both returned $ 0. I was tired of the “why” of Angel Investing ( as you describe it) and realized it. I, then, turned to real estate financing and investing and found that “cash flow” was my new investing home.

    Now I am facing the same decision, at 72, in my real estate investing. I have to turn over the operations to younger, more motivated, better managment people and accept a truly “pssive income” role. That is another tough transition.

    Ralph

    • Thanks for sharing your struggle, and continuing struggle, with your investment thesis. The people I talk to in the angel investment business usually say just keep doing what you are doing. You have always been a good investor and you’ve changed your thesis as you grew older and your risk tolerance and involvement changed. Thanks for sharing. We will get together.

    • Thanks Bill. We should talk more about this next time we are together. The investment thesis always had this as the most important criteria. Let’s talk about how I might expand on this.