August 13, 2015
Angel investing has always been a high risk, high reward proposition. In exchange for a percentage of the company, or convertible debt, an angel investor accepts the risks that come with their investment. These risks include the company going under, or their investment being diluted by future investment rounds.
In view of these challenges, what should you do before investing in a company? The answer isn’t easy, but having spent the last three years building my startup, I believe I have developed a few statistically significant insights to help you navigate the waters of angel investing using data.
1. Do Your Customer Research and Quantify It
Even if you do understand a business model, don’t underestimate the power of homework and data. Assemble anecdotal and empirical evidence to make a more informed decision. Speak with experts in the field, as well as potential and existing customers. Our team is constantly interviewing investors and borrowers to unlock insights. This same form of diligence can and should be done by angel investors.
Quantify your research: Net Promoter Score is particularly useful in determining appetite for a product. Especially in the consumer space, NPS will help inform how far marketing spend will carry the company. High NPS indicates that every marketing dollar spent will go further. Promoters fuel growth. Does Company A have two times more promoters than Company B? Assuming the companies operate in a similar space, we can assume a growth multiplier. Breaking down the NPS by category (promoters, passives and detractors) will allow you to put a “handicap” on every investment opportunity.
2. Use Search Trend Data
Google Trends is a useful tool that points to an industry that is growing rapidly by virtue of search volume trends. While not particularly useful in some spaces (especially mature ones) Google Trends may afford an investor valuable insights in choosing an industry to play in. Simple searches on “crowdfunding” and “ridesharing” indicate a huge rise in search volume. In both cases, search volume has more than doubled in 2015 over 2014. This is a good starting place for an angel investor to determine markets that are growing and weed out those that are shrinking. Beware, Google Trends reveals market trends, not necessarily market opportunity. While “ridesharing” looks like the perfect opportunity, it is obviously saturated with the likes of Uber and Lyft. Though, the intelligent investor likely sees opportunity in companies like Zen99, which is taking advantage of the sharing economy trend by offering tax and health insurance solutions to part-time workers.
3. Potential Market Size Quantification
The most innovative idea in the world isn’t worth investing in if its potential market is only a handful of people. There is an art and a science to determining market size. One of the most sophisticated VCs in the world, Marc Andreessen, challenges us to think about market potential, rather than existing market size. When sizing up Lyft and the ride-sharing marketplace he asks in a New Yorker article: “Don’t think about how big the taxi market is. What if people no longer owned cars?” While I surmise that the rest of us may not have this crystal ball-esque understanding, we should be able to peg a number on market size or at least a multiplier so that we can weigh one opportunity against another.
Take this example: a solar panel device has just changed the energy landscape forever by inventing and patenting a $50 panel that will save consumers thousands of dollars in energy bills. The U.S. has 123 million U.S. homes. Sounds like a very big opportunity! But another company has filed for the same patent in China. The Chinese company has an addressable market of 225 million homes. This grossly oversimplified example would indicate that the Chinese opportunity is nearly two times larger than the U.S. one. Of course, potential market size is a back of the envelope revealer of potential success. It is just one of many facts to considering when assessing an investment opportunity.
4. Management Team
Angel investors are often drawn as much, if not more, to the team running a company than to the service or product the company offers. Rightfully so.
Does the management team believe in their company and the product or service it offers? Are they passionate about it, or simply looking for a quick payday? Starting successful companies is hard work. The degree of passion the management team has can be a good indication as to whether they have what it takes to succeed.
But can we quantify a management team? Surprisingly, we can. First-time entrepreneurs succeed only about 10% of the time, whereas veteran founders with venture-backing succeed 30% of the time. Simply by looking for experienced founders, you can increase your odds of success three-fold. Of course, experienced founders often get the opportunity to choose from their pick of venture capital firms and angel investors. Network your way to them, in much the same way an entrepreneur would network himself or herself to you.
Despite the high risk proposition of angel investing, there are a few quantifiable metrics you can use to increase your odds of success. Of course, nothing can beat a well-weighted, diverse portfolio.
Image Credit: Flickr/Moyan Brenn
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