Spearhead asked me to write a post on angel investing when they first launched. Here’s a slightly updated version—most of the wisdom is from Naval.

Charlie Munger says investing requires a latticework of mental models. Here are 11 lessons for your angel investing lattice:

  1. If you can’t decide, the answer is no.
  2. Proprietary dealfow means ‘they want you’.
  3. Investing takes years to learn, but improves for a lifetime.
  4. Valuation matters: you will have to pass on future greats.
  5. Back $0B companies.
  6. Judgment is important but overrated.
  7. Invest only in technology.
  8. Some of the best investors have no opinions.
  9. Incentives make for bad investing advice.
  10. Play fantasy football.
  11. Power beats contracts.

1. If you can’t decide, the answer is no

If you can’t decide on an investment, the answer is no. For all practical purposes, there are an infinite number of investments out there, so pass. 

That doesn’t mean you won’t regret it. But the next investment is just as good a priori.

Your experience and judgement is only going to get better by the time you see the next deal.

2. Proprietary dealflow means ‘they want you’

Nobody thinks they have a shortage of dealflow. The hard problem is getting your money into the startups you want. The company has to want you over other investors.

Without ‘they want you,’ you will get cut out of good investments and end up with adverse selection of weaker companies. It’s okay to pass on investments, but you don’t want them to pass on you.

Missing out on a few investments can mean losing all your money because of the power law returns of investing: the top deal in a good portfolio returns as much as deals 2 through N combined. If you miss out on the top deal, you’re going to miss out on most of your returns.

You never want to hear, “I will come to you if I don’t get money from Sequoia.”

3. Investing takes years to learn, but improves for a lifetime

Get started with angel investing now. It takes years to learn and longer to see returns.

You want to invest in 30 companies at a minimum–that takes time. Start with small investments because your later ones will get better as you gain expertise and brand. So your returns will take even longer.

Investing takes a long time to learn, but it is one of the few professions you can improve until the day you die.

4. Valuation matters: you will have to pass on future greats

You can’t build a portfolio of pre-traction companies at $8-10M pre-money and expect to make a venture return. On occasion, you can make an exception, but you can’t do all of your investments at this price.

You will have to pass on great teams because the valuation is too high. You will have to pass on future iconic technology companies because the price is too high. But passing at a $40M pre-money lets you take 10 shots on goal with unknown companies at $4M pre-money.

You can’t negotiate valuation unless you’re investing 1/3 to 1/2 of the round. Or if you’re the first check in the company. Start the negotiation by saying, “I like you but I can’t make the valuation work, but I would invest if the valuation were X.”

Despite high valuations, it’s still possible to make money in angel investing. If you can’t make money in tech, you can’t make money anywhere. 

Anecdotal valuation data

Valuations for pre-traction companies between 2005-2010 were $1-5M pre-money for the first non-friends-and-family round. Funds that invested during this time period made 4x-100x returns.

These valuations moved to $4-6M pre-money after 2010, with some demo days in the $8-10M range. This likely cut returns by 2/3 or more.

Play with valuations tool on AngelList.

5. Back $0B companies

To quote Vinod Khosla, invest in “$0B companies” that could be worth $1B tomorrow.

Focus your attention only on companies with the potential for a 100-1000x return. Otherwise, pass.

Without these large exits, your portfolio will not achieve a venture return. 

6. Judgment about markets is important but overrated

Some markets are obviously bad and should be avoided. But judgment about markets is less important than you think, because there is so much luck and randomness involved. Companies can do hard pivots into new markets (Twitter, Slack and Instagram).

Judgment is not about doing a lot of research, digging and homework. By the time you figure it out, you will have missed the deal. Instead, learn a few markets really well.

Of course, you will learn about new markets over time. But learn a few markets really well. Buy all the products and try them.

Find the best scientists in the market and invest in them. They can help you with research on your next investment; this is an unfair advantage. 

Read research papers then call the grad students who wrote them. Waiting to learn about new markets on TechCrunch is too slow.

7. Invest only in technology 

The best returns come from investing in technology companies. Avoid companies that don’t develop meaningful technology (either software or hardware).

The 5 largest companies in the S&P 500 (Apple, Google, Microsoft, Amazon, and Facebook) are all technology companies. The largest private companies are also technology companies. 

There are exceptions like Dollar Shave Club. Their early investors had good returns. But, as a rule of thumb, you should only invest in technology.

8. Some of the best investors have no opinions

“I have no idea what’s hot. But I’m certainly always listening. Big Dumbo ears. Just listening.” – Doug Leone, Sequoia

Some of the best investors on the planet have no strong opinions about a particular business. They try not to project into the future, so they can listen intently in the present.

Almost any entrepreneur will be smarter than them in their market. The investor’s job is to listen and decide whether the founders are smart, honest, and hard-working. 

These investors don’t fall in love with a business. When it comes time to do a new round, they re-evaluate the business from scratch and ignore sunk costs.

If you’re thinking about all the great things you could do if you were running the business, you’re going down the wrong path: you’re not running the business.

If you are telling the entrepreneur what to do, don’t invest. Thinking like an investor is different than thinking like an entrepreneur who is determined to make a business work.

9. Incentives make for bad investing advice

Incentives influence the advice you get from VCs, lawyers, incubators, and everybody else. Everyone serves their own interests first. The best source for angel investing advice is other angels and founders.

People are generally well-meaning but, in the words of Upton Sinclair, “It is difficult to get a man to understand something, when his salary depends upon his not understanding it!”

10. Play fantasy football

Build your instincts by looking at startups without investing. This will build your instincts, which is what you really use to make investment decisions.

In the old days, you had to work at a VC firm to see dealflow. You had to make a few investments and lose money before getting good judgment. John Doerr called this “crashing a fighter jet.”  First you lose $25M, then you have some judgment.

Now you can get judgment without crashing the fighter jet. You can see dealflow from your friends, your incubator, demo days, and AngelList.

You need a lot of data to build up your instincts. Track your fantasy portfolio and anti-portfolio. Write down what you like and dislike about each deal and see how your judgment develops over time.

11. Power beats contracts

Contracts can be renegotiated. You will be pressured to renegotiate your investment by founders and VCs. If you’re alone, you won’t have the power to fight back.

Contracts are written for worst-case scenarios, so people can’t outright steal your money. Suing people is bad for your dealflow. So real-world decisions are usually based on power.

If you’re the only seed investor in a round, you can get screwed. There aren’t enough co-investors to make a ruckus if the company wants to:

  • Recap and start over
  • Raise the cap on your convertible note
  • Give your pro rata to a new investor

If you’re alone, you won’t have the power to fight back. The startup and their new investors can pressure you to renegotiate. So don’t be a herd animal when making an investment decision, but move with a pack when you do. 


Venture Hacks is now independent of AngelList

Muchos thanks to AngelList for assisting with this transition (Aaron, Jake, Kevin).

The first version of AngelList was a blog post on Venture Hacks. It shipped in one day, maybe two. I don’t know if anyone remembers, but it was called AngelBase back then. They’ve come a long way since then.

Now, Venture Hacks is going solo with new posts on fundraising, investing and good times. 

More thanks to WordPress (Andy, Chris, Matt) for hosting us on Pressable. And for cleaning up this old blog which launched on April 1, way back in 2007.

Some highlights from Ed Catmull’s Creativity Inc. Ed is the President of Pixar.

“If there is more truth in the hallways than in meetings, you have a problem.

“The desire for everything to run smoothly is a false goal.

“The truth is, the cost of preventing errors is often far greater than the cost of fixing them.

“Rules can simplify life for managers, but they can be demeaning to the 95 percent who behave well. Don’t create rules to rein in the other 5 percent—address abuses of common sense individually. This is more work but ultimately healthier.

“The first conclusions we draw from our successes and failures are typically wrong. Measuring the outcome without evaluating the process is deceiving.

“An organization, as a whole, is more conservative and resistant to change than the individuals who comprise it. Do not assume that general agreement will lead to change—it takes substantial energy to move a group, even when all are on board.”

This guest post is by Tyler Willis, an entrepreneur and angel investor. You can learn more about him on AngelList.

For several interesting macro-economic reasons [1], more and more people are becoming angel investors.

This is a good thing – it allows more investors to participate in a high-growth (but high-risk) area of our economy. That said, investing in private companies is very different from investing in public companies.

People who are just getting started in angel investing should get comfortable with the inherent risks and learn the strategies required to be successful angel investors. Without doing this, you run the very real risk of losing every dollar you invest in this market.

Two years ago, my first company was acquired by Oracle and four members of our early team, including myself, became part time angel investors. Before I started investing, I tried to learn as much as possible about angel investing. In all of the things I read and people I talked to, two posts stood out as particularly helpful: Paul Graham’s post How to Be an Angel Investor and Naval and Nivi’s How to be an angel investor, Part 2. These posts were helpful because they did away with the inside baseball and tried to present a comprehensive overview for a novice investor.

This year, several of my friends became accredited and asked for my advice on angel investing. Inspired by the opportunity to help them, I looked back on my first year of investing and tried to tie all of those lessons up in a comprehensive overview–think of it as Angel Investing 101. Drawing on the previous two posts, I called the presentation How to Be an Angel Investor, Part 3.

Success as an angel investor boils down to whether you can pick the right companies. The information in this presentation won’t make you a successful angel investor on it’s own, but it can help you avoid the common pitfalls and develop a better understanding of how this market works and whether you’re ready for it.

Because these investments are illiquid, you won’t know for many years whether you are doing a good job of picking the right companies. My best advice is to focus first on learning as much as you can so you can avoid common pitfalls. Once you’ve done that, budget money you can afford to lose and start slowly. You’re generally going to be better served by spreading your initial investment budget over several years, rather than trying to invest it all in a short period of time.

If you find this useful, I intend to create more free resources for angel investors (including video interviews with successful investors sharing their best advice). If you’re interested in more information like this, check out adviceforangels.com.

[1] Broadly, we’re creating a much more affluent upper middle class. Tyler Cowen’s book Average Is Over is a good read about this if you’re interested.

Specifically, there are a few big changes that have created more angel investors.

  • Startups provide equity compensation by default, so the influx of new startups means that more people employed under this model.
  • Companies are staying private longer, which incentivizes investors to move to private markets in search of good returns.
  • It seems likely that startups will share more equity with employees than they have historically (this is a prediction, but we’re starting to see early examples of this)

Must be a 1-(wo)man startup.

Must code. Must write good copy.

Must be passionate about solving problems for our customers, not “designing.”

Must fix other people’s designs and front-end code on production (people ship whenever they want).

Must help our 1-(wo)man startups with their design problems. Must force your help on them when needed.

Must take the words of our founders/whomever straight to mocks without worrying about whether we’re going to build it. Make the mocks, then start evaluating the idea. Pivot it when necessary (always).

I do the onboarding for all new AngelList team members. Part of it is asking them to read the following (many candidates have read these before they even come in for an interview).

Culture

Startups are here to save the world
Things we care about at AngelList
Doing the wrong things the right way

Execution

Ask forgiveness, not permission
1-(wo)man startups
No email at AngelList
6-year vesting
Customer Service
Internal 360 Review (redacted)
Company Strategy (you wish)
Internal Github engineering wikis
AngelList Twitter Favorites

Writings that have influenced us

Engineering Management by Yishan Wong, ex-Facebook Engineering
Hiring by Paul English, co-founder of Kayak
Freedom & Responsibility by Netflix

We care about:

  1. Eliminating frictions so startups can change the world
  2. Connecting startups with their ideal partners, on the best terms, fast
  3. Building tools for investors to help startups
  4. Telling startups and investors what we would want to know in their shoes
  5. Building products that scale, instead of manual processes or throwing bodies at the problem
  6. Having team members work on things they’re excited about, rather than what we think is important

Some things we try to care about at AngelList.

Learn More: Startups are here to save the world, The entrepreneurial age and No tradeoff between quality and scale

How much traction do you need to raise $1M? AngelList’s Ash Fontana has the answer on TechCrunch:

slide

Read the post for details and also see these comments by meMichael Wolfe, and Shallaba.

We use very little email at AngelList. Most of our communication happens on Yammer, HipChat, Tracker and face-to-face. This probably gets us a 90% reduction in email.

If you’re running your company via email, you’re missing out on newer, more effective communications technologies.

Yammer is our company mailing list

Yammer has nested conversations, search, inline images and likes. It is also our company directory. And they have a mobile app.

We use it for asynchronous communication across the whole company. Most of all, it keeps our company “mailing list” out of email.

Yammer, HipChat and Tracker all have email, mobile and desktop notifications. You don’t need to check them every 5 minutes.

HipChat is for IM

HipChat is an IM app for desktop and mobile. It has inline images, presence, search and a company directory. The (buggy) iPhone app keeps you accessible when you’re out of the office.

It also supports multi-person rooms (we have a room for our engineers) and it has an API that we use to feed other rooms with exceptions, GitHub notifications and deploys.

We use HipChat for synchronous 1-on-1 and group communication.

If you’re using Skype for IM, try HipChat. Alternatives include Yammer, which has rudimentary IM. Or a Facebook group which has a wall and basic IM. But I recommend HipChat.

Tracker is for product specs

We use Tracker to spec out goals and tasks for new features. Each spec has its own todo list, image attachments, comments and status. It’s also easy to re-prioritize features and assign them to different people. Some people prefer Asana or Trello for specs.

Face-to-face is for everything else

The biggest companies weren’t built remotely. Families don’t live remotely. Sports teams don’t train remotely.

Face-to-face is for high bandwidth communication, sub-communication (body language and facial expressions), leaving an impression, new ideas, overhearing other people’s conversations, bonding with your co-workers, whiteboarding, throwing chairs, and everything else you need to say to build a big business.

When we use email

I discourage new team members from using email, but there are a few places where we use it.

First, when we need to communicate with people outside the company.

Second, when we need to have a conversation with an ad hoc group of people inside the company. HipChat is not great for ad hoc groups that only need to discuss a single task like, “how should we negotiate this deal.”

Third is laziness and stupidity (guilty).

Update: There’s an excellent discussion of alternative approaches on Quibb.

Screenshots

Here are screenshots of the mobile apps. They all have desktop apps as well.

Yammer

20130322-111832.jpg

HipChat

20130322-112017.jpg

20130322-112244.jpg

Tracker

20130322-112324.jpg

My Inbox

20130322-155221.jpg

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Every team member of AngelList is on a 6-year vesting schedule. Including the founders. Why?

Because it takes a long time to build something important. And we want everyone to stick around for a long time.

Because we want people who are here for the mission, not a payday.

Because it sells prospective hires: the team you’re joining isn’t going anywhere.

Does that mean I get more equity?

Everyone asks whether they get more equity to make up for the longer vesting schedule. A good way to think about that is whether we would give smaller grants if new team members were on a 4-year schedule. And the answer to that is ‘yes’.

There are a lot of benefits to getting additional equity now, instead of 4 years from now:

  1. The strike price is today’s strike price, not a higher strike price 4 years from now.
  2. The clock on long-term capital gains starts as soon as you exercise the grant.
  3. A new grant 4 years from now wouldn’t be as big.
  4. Any acceleration is likely to consider the entire grant, not a smaller 4-year grant.

If you’re interested in a 6-year vesting schedule, AngelList is hiring engineers and designers.

Related: 1-(wo)man startups and Ask forgiveness, not permission

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