Become an early-stage angel investor with Airtree, Startmate, Ten13, VentureCrowd and others
Growth in angel investing really took off in 2021. While it’s difficult to measure how much private money lands in tech founders’ hands, hundreds of programs have sprung up all over Australia to form syndicates and educate individuals who want to angel invest.
Last year venture capital firm Airtree launched its Explorers program: a course for newbie angel investors to understand the ins and outs of this type of investing and generate deal flow. In addition, Startmate has its First Believers program and UNSW has an angel investing course.
UNSW’s Onay says the idea is to share the due diligence across a group of people, and allow those with smaller amounts of capital to still participate in larger investment rounds.
“More people are getting into syndicates, which is great for the ecosystem,” she says.
“We used to just have investment bankers or real estate investors or software engineers, but now we’re seeing people from very different industries put money in, as well as their diverse expertise.”
How to start
The first thing to acknowledge is the high risk that comes with early stage investing.
It’s one of the riskiest investments out there and, Scale’s Robson is quick to point out, is very much driven by people, not by a deep equity-type modelling that will forecast future cash flows and a clear return-on-investment.
“Your job is to back someone who is fulfilling their dream,” Robson says. “You are handing over your money to someone who you believe can make some serious value out of it.
“That takes belief in the founder, who might not have a proven track record yet and might be operating in a technology or with a business model you’ve never seen before.”
Rayn Ong, founder of Archangel Ventures, is well known around the start-up traps and has been angel investing for the last eight years.
A straight talker, Ong says he married rich and was given some money by his father-in-law to try to profit from the internet boom.
“I thought that I could either start my own start-up or I could invest in other people doing that,” he says.
Investing in early-stage tech companies is generally considered an alternative asset class, and sits alongside private equity, venture capital and the emerging, but much-hyped, cryptocurrency investing.
As such, experienced angel investors will usually allocate less than 10 per cent of their net worth to their early-stage investments. Some cheques can be as little as $5000 while otherwise are north of $1 million.
“Start-ups can be very illiquid – you’re waiting for a secondary investment or an IPO and there’s no guarantee you’ll get it back any time soon,” Ong says.
“So if you need your cash back tomorrow, it’s not a good investment. So don’t bet the whole house on start-ups.”
Where to invest
Once you’ve carved out your allocation, the next step is to find your place on the risk spectrum within the tech start-up ecosystem.
Ong says new investors should consider whether they want to invest in private equity opportunities, which are generally within more mature companies that might be close to an IPO.
Venture capital investments tend to emerge when the company is growing quickly and needs more money to turbocharge that growth – a step up from early-stage angel investors, who write the first cheque.
Spread your risk
Then it pays to work out how to diversify the portfolio.
Robson recommends starting small and anticipating that you’ll likely make multiple investments – at least 20, with as many as 40.
“You want as many bets as possible,” says Robson, adding it’s important to keep some capital aside in case the business needs more.
“Needing more capital down the track isn’t necessarily a reflection they’ve gone badly, rather it sometimes means they’re doing really, really well.”
One mistake she sees often is newbie angel investors writing a cheque that’s too big, limiting their chances of a successful deal.
“Usually it’s the first cheque they’ve written,” she says. “It’s really easy to fall in love with the first great idea you come across, but you really need some other options if that goes to zero.”
Ong agrees, saying he aims to have 30 to 40 investments in the one “vintage”, giving him as much exposure to as many businesses as possible.
“That way, when I lose a company or it dies, I only lose a fraction of my total allocation,” he says. “But when one of those companies does well, I can 10 times my money.”
Robson says investing in what you know is a powerful way to add value to a start-up company, but it can also throw up ancillary benefits for your career.
“Early-stage companies sometimes have innovative business models or different ways of approaching problems, and you can often apply those learnings in your day job,” she says.
Where to find opportunities
There are many ways to find start-ups to invest in. Submerging yourself in meet-ups and within the ecosystem is one such way, but most angel investors join a syndicate or group that source and discuss deals together.
In Australia, there are investor syndicates like Ten13, an investment platform for people to co-invest alongside a Brisbane-based fund. There are also angel networks and groups, like the 361 Angel Club, which shares deal flow, and Impact Club, which focuses on social and environmental deals.
Investors can also find deals through equity crowdfunding platforms such as real estate-focused VentureCrowd and agriculture and energy-focused AgCrowd.
Like any other investment, there’s a fair amount of due diligence that needs to be done. For this reason, Ong recommends looking into fields you’re already familiar with.
“It’s personal preference, but it’s hard to be the master of everything,” he says. “Think about how much time you can dedicate to understanding a business model or industry.”
In Australia, there are tax incentives to boost angel investment in start-ups. Most notably, investors in “early stage innovation companies” (ESICs) can receive a 20 per cent non-refundable carry-forward tax offset, capped at $200,000 per investor each year.
They also receive a 10-year exemption on capital gains tax for investments held as shares in an ESIC for at least 12 months, as long as you don’t hold more than 30 per cent of that ESIC.
Who can invest
While the incentives to angel invest are juicy, there is much debate within the tech ecosystem about the “sophisticated investor” test. As it stands, only sophisticated investors can invest independently in start-ups.
Under current regulations, most “sophisticated” investors must have net assets of at least $2.5 million or gross income of at least $250,000 per year.
But what about investing via a syndicate? It depends on the syndicate. Most do require you to be “sophisticated”. However, some also accept other investors depending on experience levels and investments.
If you don’t pass any of these wholesale investor tests, you can invest directly in a startup as a retail investor via equity crowdfunding platforms investing up to $10,000.
“It’s a bit frustrating to know there are really knowledgeable and well-educated potential investors who don’t make those financial metrics,” Robson says.
“Maybe we should rethink some of those investor tests because many people are disadvantaged [because of this] and can’t make the financial return that they otherwise would, given their expertise.”
UNSW’s Onay agrees, pointing out that regulations in the UK and US are often knowledge-based or experience-based, rather than wealth-based.
“Just because you’ve got a lot of money doesn’t necessarily make you a smarter investor,” she says. “It should be based on knowledge rather than how much money you have.”
Getting the fine print right
Finding and deciding to invest in an early-stage start-up is often the hardest part, but drawing up the term sheet (or letter of intent) is often the most important.
As it stands, term sheets around Australia are generally pretty standard – they outline how much you’re paying for your slice of the company, which generally reflects the total valuation. They also outline how much equity is held by the founder and other participants.
Ong says he generally tries to include a “pro rata” clause, which gives him the power to maintain his shareholding as well as invest more money if he wants in round two.
“Everybody is different, and some people want more downside protection, but I want to participate in the upside and buy more,” he says.
Downside protection is generally required when a start-up raises a round that values the business less than its previous round.
Robson agrees, adding; “Arguably you’re taking on the biggest risk by being the first investor, so you want the opportunity to invest more.”
She also says it’s important to make sure the founder still has a sizeable equity in the business.
“You want their incentives to be clearly aligned with yours,” she says. “There’s a reason they left to start a start-up, and you want them to see through their idea, not lose interest and feel like they’re back working for someone else.”
Take a long-term view
Once the term sheet and shareholder agreements have been decided, angel investors need to practice patience.
This, Robson, Onay and Ong all agree, is much easier said than done.
“You absolutely need to remember you’re not running this business,” Robson says. Too often, angel investors become overly involved in the start-up, demanding reports and updates that distract the founder from executing on the idea.
Another problem is when angel investors become fixated on profitability, when growing revenue is often a more useful metric.
“Some people get too involved, and it can be a problem,” Ong says. He adds that investors are generally chosen because of their networks and connections, which can help the start-up hire well or raise more money.
“But at the end of the day, you’re the investor, so don’t get too much in the founder’s face.”
While fast-growing start-ups attract glowing headlines, it’s worth remembering that most start-ups fail. Angel investors, who are exposed to the earliest phases, are often the first to see the wheels coming off their investments.
“You can try and replace the founder, or you can try and assist with your connections. But when a business fails, there are generally way more reasons than just one,” Robson says.
Ong agrees. “This is the riskiest end of the market, so you need to be prepared to lose some money,” he adds.