Angel Investing: What you don’t think about

Yes, we have all seen the glamorous side of startup investment, but before you invest in any startup as an angel investor, there are a few things you should know and think about.

Being an angel investor, I have learnt a few things that I would like to share as you might not have paid attention to it earlier.

Startup investment is a new asset class which has garnered strong interest from retail investors lately. More than 2,250 tech startups were founded in India in 2021, as per reports. That is approximately 6 new startups being registered every day in the last year in India! (Just Tech Startups!)

From 471 registered startups in 2016 to 72,993 registered startups as of 2022, one can see a strong rise in entrepreneurial spirit in our country.  

With this rise in startups, retail investors are exploring angel investment as an area of interest due to the high return potential.

 

For my fellow readers wondering, who are angel investors? Angel investors are individuals who offer promising startup companies funding in exchange for a piece of the business, usually in the form of equity.

We all have heard someone say “If you had invested in this startup in 2015, then today you would have made 2000% return on your investment in 4 years” 

Yes, we have all seen the glamorous side of startup investment, but before you invest in any startup as an angel investor, there are few things you should know and think about.

Let’s take an example,

Amit recently got a promotion and wants to invest the additional income in startups considering the high return potential.

He checks on LinkedIn and comes across an interesting business proposition. Considering his expertise and interaction by the founder, he decides to invest INR 2 Lac in the startup. Amit didn’t want to pay the investment facilitation fee and thus decided to directly invest in the company . His thoughts being, “I am paying an amount and getting shares in exchange, why should I pay for anything else anyway?”

Guess what, there are a lot more things to evaluate and consider. Let’s take them point by point.

• At the time of investment

• Difficulty in Conducting Due Diligence: Being an angel investor, it is extremely difficult to even evaluate a due diligence report. Conducting a comprehensive due diligence is a different ball game altogether.  

• Negotiating Legal Rights: The shareholder agreements are 50-100 page long documents that contain all the legal rights of the investors (like Information Rights , Liquidation Preference, Exit Rights and others which are complicated to understand) and corresponding obligations of the founders. The construct of the document can impact the investor's accessibility to company financials, business decisions and even exit and the returns thereof.

• While you are invested

• Difficulty in receiving the latest MIS: It is easy to get MIS & other information from the founder while investing. But after the investment, it may not be equally easy. If one has incorporated the rights in the agreement then it may be possible to legally pursue the founder for getting key updates but the question remains, why would investors push legally when the action can endanger the survival of the company. Thus, it remains a grey area.

• During Exit

• No Bargaining Power: It’s all great to hear about the startup’s valuation increasing over a period of time. 10x-20x “nominal” returns within a couple of years but one needs to find a buyer to realize those returns. Being an individual angel investor with a small ticket size drastically reduces the bargaining power compared to that of a fund/group of investors

•  Lack of exit rights: It is extremely difficult to negotiate for exit rights for individual angel investors. This reduces the chances of being able to exit along with the majority stakeholder in the company. 

Considering all these points, should you give up on angel investing? No, it is a highly exciting asset class. However, there are various modes of investment such as Angel Funds that allow you to invest a small ticket size in startups while also allowing you to receive the rights & opportunities like an institutional investor. That being said, It is extremely important to choose the right angel fund as well. Hopefully by the end of this series, you would know everything about angel investment to make the right choice

So in the next part of this series, let’s talk about things that you should ask your angel fund before investing with them.