How Many Startups Should You Invest In?
Updated: Jul 10, 2019
One of the first questions that are asked by those looking to become angel investors is: “Can I really make money investing in startup companies?”. Unfortunately, there is no easy answer to that question. A a UK Corporate Finance Consulting firm we have certainly come across very successful investors with only a handful of investments, while others might have quite a broad portfolio.
When you’re looking to become an angel investor, it’s crucial that you understand the risks that are being taken and how you can mitigate those risks. And the best way to do that is by building a very diversified portfolio.
At first, it’s important that you primarily focus on getting very diversified, fairly quickly. While you may have a goal of how many companies you want to invest in, or a target total amount of capital – all of that fails in comparison to the importance of diversification. The more investments you have, within the bounds of being able to manage them, the better.
In terms of managing, we mean simply keeping on top of them. That includes staying current with their messaging and strategy, helping them when necessary, having capital available to follow on and be able to maintain a relationship with the CEO. There is always a limit to the number of companies you can successfully manage at once, but you should try to have as many as possible for your time.
It’s also important to keep in mind that every portfolio reaches a natural plateau at maturity and the exits begin to offset the new investments. How many active companies that plateau
represents is a function of the pace at which companies are added (particularly good companies – if you have lots of “fast failures”, that will bring the numbers down).
Here’s an example of how the law of plateaus works: if you assume most companies take 5-10 years to reach an exit, and 50% of your companies fail in their first three, as the companies in the portfolio age, eventually the rate of harvest will come into approximate equilibrium with the rate of replacement and your portfolio will plateau. However, there are just guestimates as every portfolio is unique.
Another important reminder for new angel investors is that the majority of your returns are going to come from a tiny fraction of your investments. Massive wins are really rare, no matter who you are, and no matter where you are.
Given that you are relying on big, rare wins to build the bulk of your returns, it stands to reason that you want to maximise your chance of hitting those. You can do this by picking out great companies, helping your companies succeed and following on in your early breakouts. But at the end of the day – having enough mathematical chances to even be a big winner is the most influential factor.
Overall, when just starting out as an angel investor, the best thing you can do is keep the pace of investments relatively high to begin developing your diversification and quickly overcoming the learning curves that come with building a portfolio of startups. Getting more money into winners and increasing your chances of finding the big wins are key to getting your angel investments up and running.