Angels Posts

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 that 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. Your instincts are 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. 

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

[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)

Last week, Naval and a slew of angels shared their investing advice with an audience of angels-in-training at AngelConf 2010.

Wade Roush at Xconomy took detailed notes on all the talks and published them here and here.

7 angel investing tips

Here are Wade’s detailed notes from Naval’s talk:

“1. Don’t move in a herd, but do be a pack animal. Not everybody has all the information. One angle might know the market, one might know the founder, one might know the customer base. Every time an angel comes into a round, they bring a piece of information. Ride on their coattails.

2. Say no early and often. You should be doing one deal for every 20 to 30 that you see. If you do more than that, you’re overinvesting.

3. You need to have a brand. The really great deals are obvious, and everybody wants in, and if you want to get in you need a brand. That could be that you have been successful with great companies in the past. And building a brand does not mean taking coffee meetings. Shallow connections do not mean much. If you have a fancy office on Sand Hill Road or Market Street, the best deals are not going to come to you. If you’re not out there running around getting to know people, then you are really just practicing the VC model.

4. Humility. When you’re sitting there all day and people are asking for money and more often than not you are saying no, it eventually goes to your head. The problem is that when a Mark Zuckerberg walks in, those guys have more offers than they have room for. If you come across as arrogant, they will drop you.

5. Your job is to be a little dispassionate. Don’t try to run the company. Don’t even take the power—if you don’t have it, you won’t be tempted to use it.

6. Filters. Every winner is unique by definition, because what they’re doing is new. But the losers tend to cluster around common mistakes, such as investing in a company with one founder. You will find you can establish filters, even one as simple as “Do what you love.”

7. There are many paths to success. You have to be very careful about taking your limited experience and trying to shoehorn your companies into it.”

Paul Graham says “The future [of funding] is no fixed amount, no fixed closing date, and no lead.” In other words, the future of financing is continuous, not discrete.

This post explains how to raise a seed round with no lead, no fixed amount, and a fluid closing date. The process is called mass syndication, or a party round.

Paul proposes eliminating rounds altogether, but we’re not there yet. Mass syndication is a single continuous seed round and I think it’s the state of the art in continuous fundraising.

We originally offered this interview exclusively to AngelList applicants — now it’s available to everyone.

Another future

The future of funding is also finding the right investors for your startup, quickly. Not just picking from the investors you can get introductions to.

How? You want to get instant meetings with any investor you want. And you only want to meet investors who are genuinely interested in your startup. That’s what AngelList is for. One danger of this approach is that your round is oversubscribed.

Despite the name, you can use AngelList to request intros to any subset of investors on the list — you don’t need to send it to the whole list.

Leads aren’t going away

Fred Wilson writes “If you don’t want a lead investor, then don’t knock on my door because I don’t know any other way to be.”

This interview explains how to raise a seed round with the conservative assumption that a lead won’t step forward — but it doesn’t preclude you from changing course if a lead appears.

1. Interview

Video: Interview with chapters (for iPod, iPhone, iTunes)
Audio: Interview without chapters (MP3, works anywhere)
Transcript: Below

2. Outline

Here’s an outline and transcript:

  1. You can close an angel round with ‘mass syndication’
  2. Start with terms and valuation below market
  3. What you want in your term sheet
  4. What you don’t want in your term sheet
  5. Should you have a board seat for seed investors?
  6. This isn’t comprehensive term sheet advice
  7. Memorize the term sheet before your first meeting
  8. How do you set your valuation? Price it to move
  9. How do you bring up the terms in a meeting?
  10. Describe how the terms are investor-friendly
  11. A preferred round is a good way to set up good initial terms
  12. Does a small seed round need protective provisions? Pros and cons.
  13. Get feedback on the terms in the first meeting
  14. Drop names to build social proof
  15. Social proof works differently in a Series A round with VCs
  16. See if the “interest” includes a dollar amount, intros, and name-dropping (a.k.a. soft circled)
  17. When do you need a lead?
  18. Approach the financing as if you won’t find a lead
  19. What’s a lead investor?
  20. If they say “find a lead,” ask why
  21. How to create a deadline
  22. Raise the money when you don’t need it
  23. Send two emails to the angels
  24. Do a rolling close: the cash comes in just- in-time
  25. Mass syndication can fail if a very high social proof investor drops out
  26. Use AngelList and StartupList to get intros to angels
  27. What do angels look for?
  28. Advisors are good for getting your foot in the door, not in a pitch
  29. Get advisors by going to events or talking to entrepreneurs
  30. Before you raise a seed round, you need a product in the marketplace
  31. Use customer development and lean startup techniques to get to market with less
  32. Pitching hacks free chapter: Advice on getting investor intros
  33. If you need money to get something in the marketplace, pitch idea investors
  34. Pitch incubators or do your startup on the side
  35. What are the different types of seed stage investors?
  36. If you’re talking to a VC, make sure they really do seed stage rounds
  37. Potential concerns with pitching multi-stage and seed-stage firms
  38. Get intros to seed investors with AngelList/StartupList

3. Transcript

Music: Squarepusher

Nivi: Hi there, this is Nivi from Venture Hacks.

Naval: And Naval from Venture Hacks.

Nivi: And we’re going to talk about how to close an angel round, how to put together an angel round, or in other words, how to herd a motley crew of angel investors and turn those meetings that you’re getting into money in the bank.

I think we’re going to start off by talking about mass syndication, which is an approach that I think more entrepreneurs should be taking to close their angel rounds.

You can close an angel round with ‘mass syndication’

Nivi: I think entrepreneurs make two typical mistakes when they’re doing an angel round, and they come from what they’ve read online about how to close a VC round. So, there are two things.

One: they don’t name drop enough. They don’t mention who else is interested.

Two: and I guess more importantly, they’re looking for a lead, which you don’t necessarily need in an angel round.

When you put those two together and combine them with a term sheet that you essentially write yourself, you’ve got a new way to close an angel round which we call mass syndication, which I’ve done personally. And Naval, maybe you can talk about how often you see that happening, or if you don’t see that happening, or whatever.

Naval: It happens fairly often these days. Especially the Y Combinator companies, which are well trained by Paul Graham and crew, will exercise mass syndication a lot. So, they take the standard term sheet that they’ve been given and they go out and do a rolling close of various convertible notes. And it generally works pretty well.

The keys are that you have to set the terms and the valuation very, very reasonably. In fact, you have to probably price slightly below market, because otherwise the angels don’t trust you, then they want a lead who’s done the due diligence. You have to work with people that you have warm intros with, you have to name drop like crazy, and you have to create forcing functions to get the round to close. You can’t give people all the time in the world.
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My friends in Boston are running Angel Boot Camp (@angelbootcamp) in Cambridge, MA on June 1:

“Have you thought about angel investing but weren’t sure whether it was right for you or how to get started? Are you an entrepreneur who wants to learn more about working with angels and how angel investment differs from venture capital? Here’s a chance to learn from the experts.

“Why do angel investing? How do you find and evaluate potential investments? What’s the right amount of money to invest? How do you set terms? How do you work with other angels, entrepreneurs and VCs? What are the legal issues?”

The speakers, presented in a 4×4 array, look great:

If you’re a Boston angel, check out the Boot Camp. Startups are invited too. And when you’re done, join AngelList.

Boot Camp: Stay-at-Home Edition

Angel Boot Camp is modeled after Y Combinator’s AngelConf. Angels who want to learn more about angel investing should read this excellent essay by Y Combinator’s Paul Graham: How to Be an Angel Investor. And this semi-excellent interview with me and Naval: How to be an angel investor, Part 2.

Without angel investing, there would be no VC investing. Fred Wilson writes, “The angel funding mechanism is potentially the single most important funding mechanism in startup land.” I couldn’t agree more.

Last week, I tweeted some thoughts for first-time entrepreneurs raising money and asked Naval, Chris Dixon, and Mark Suster to chime in. Here are the results.


If this is your 1st time raising money…

  1. It takes way longer than you think.
  2. You’ll assume you’re much further along than you really are.
  3. It’s not about optimizing the round, it’s about whether you can raise the round at all.

Naval (@naval)

If this is your 1st time raising money…

  1. If you’ve launched and have traction but you’re not getting funded, your team is likely the problem. Look in the mirror.
  2. Your financing usually goes nowhere until you’re suddenly oversubscribed.
  3. Launch first, raise later.

Chris Dixon (@cdixon)

If this is your 1st time raising money…

  1. Make sure the valuation is one that you can get a 2-3x step up on if you hit your milestones.
  2. The earlier the investment stage the more you should think of them as partner versus buyers of stock.
  3. After 3 months of pitching, you risk being perceived as damaged goods.

Mark Suster (@msuster)

If this is your 1st time raising money…

  1. The biggest problem is “anchor tenants.” Once you get them, the lemmings will follow.
  2. Everyone wants a “deal.” Even rich people. Get the highest profile anchor tenants and give them a deal. My commentary is specifically related angel investing.
  3. Everyone obsesses with dilution from investors. The biggest dilution comes from co-founders. If you have 2 co-founders, you’ve diluted 66% before doing any of the hard work. Start by yourself and bring in co-founders for smaller stakes once you’ve got initial momentum. Unconventional wisdom, but the most economically practical advice you’ll ever get.

I recently got on the phone for a cross-continent conference call with Chris Dixon from Founder Collective, Mark Suster from GRP Partners, and our own Naval Ravikant. The topic was VC signaling in seed rounds — and how these signals help or hurt your ability to raise money in the next round.

The interview was inspired by Mark Suster’s (VC) and Chris Dixon’s (super-angel) discussion on whether entrepreneurs should take seed money from VCs — and Mark’s claim that “if we discussed the issue live we’d probably end up agreeing more than disagreeing.”

This is the first time we’ve interviewed so many people. The resulting interview is fun, with lots of actionable info for entrepreneurs — at one point, Naval asks if we’re getting too deep and my response was roughly hell no.

SlideShare: VC signaling in seed rounds
Audio: Interview with chapters (for iPod, iPhone, iTunes)
Audio: Interview without chapters (MP3, works anywhere)
Outline and transcript: Below

Thanks to the SlideShare team for helping us resolve a technical issue very quickly.
[

Howard Greenstein from Inc. recently interviewed Naval and me for a post called 5 Questions for an Angel Investor:

Howard Greenstein: How does a start-up know when it is ready for Angel funding?

Venture Hacks: If you’ve just got an idea, check out incubators like Y Combinator and TechStars. Or you might be able to convince someone who knows you well (a former boss or family member) to invest. Or you might be able to convince someone who knows the market really well  (they’ve had the same idea as you) to invest if they believe in the team.

If you’ve got amazing pedigree and connections (your last company was acquired and the investors made money) you might be able to raise money on just that alone. If investors are clamoring to invest before you start raising money, you can take this route, otherwise, you can’t.

Otherwise, build something (anything), put it in the hands of customers and get some traction before raising money. Any hardware/software/whatever startup can do this thanks to lean startup and customer development techniques and the decreasing costs of doing *everything* — the exception is startups with predominantly technical risk. Also get some social proof (brand name advisors) before contacting angels. Social proof lubricates getting in the door.

Read the rest of the interview for our answers to 4 more questions, including our thoughts on what to look for in an angel and trade-offs between raising money vs. boot-strapping. I think the interview turned out well. Thanks for pulling it together Howard.

Bill Burnham, hedge fund manager and former VC:

“Angel investors are becoming the dominant force in Consumer Internet Venture capital. The vacuum created by the withdrawal of VCs from traditional Seed and Series A opportunities in the Consumer Internet space has been filled by a motley collection of angel investors. It is angel investors, not VCs, that are writing checks based on good ideas, business plans, and “alpha sites”; not VCs. The importance of angel investors is such that it is not unusual these days to see an internet startup publicly announce its round of angel funding, when in the past such events did merit a public mention. Yes, angel investors have always provided seed money, but today they typically provide 100% of what was once considered Series A money as well.”

(If only there was a list of angel investors…)

There’s also a good discussion in the comments. Bill says:

“My take on most seed/ super-angel funds is surprise, a fairly cynical one. I think if you offered $1BN to the managers at these seed stage funds they would go from Seed focused to multi-stage in a remorseless heartbeat.”

Dave McClure replies:

“no, i wouldn’t trade my model for that bowl of bullshit, even for the bigger paycheck in the short-term. it’s just not sustainable.”

Read Bill’s full post.

I would like to hear from VCs who are co-investing and competing with these angels. What seed stage companies are you investing in? What were the company’s metrics like when you invested? Are you seed stage (plus follow-on investments) or truly multi-stage?

Naval and I recently put together a talk for AngelConf, a conference for new angel investors. The conference was organized by Y Combinator and included a great group of notable angels like Ron Conway. According to the AngelConf website,

“Investing in startups seems mysterious and difficult. How much are you supposed to invest? What legal agreements do you need? Where do you find startups to invest in? How do you pick winners?”

People liked Naval’s presentation — Dave McClure called it an “awesome fucking talk“. So we thought you might like it too — it’s good advice for investors and entrepreneurs alike.

Paul Graham from Y Combinator wrote up his talk in a wonderful essay called How to Be an Angel Investor. So we’re calling our presentation “How to be an angel investor, Part 2”.



Slides: How to be an angel investor (pdf)

Audio: mp3


Here’s a transcript of the conversation. I’ve highlighted some of my favorite bits.

Nivi: Hi, this is Nivi from Venture Hacks.

Naval: And this is Naval from Venture Hacks.

Nivi: Naval recently gave a talk at Y Combinator’s AngelConf on how to be an angel investor and we thought we would record it — people liked the talk — and we thought we would record a slightly longer version and put it online.

Naval’s going to do most of the talking and I’m going to jump in with a question or a comment.

Naval Ravikant

Naval: So, I’ve been in this business for a little while now, been involved with starting about seven companies, been an investor as an angel or a VC in well over 30 companies and been an advisor to over a dozen companies, and of course co-author Venture Hacks with Nivi.

After a while, you do enough of this and you start pattern matching — you notice a few things — and so I’ve put those together here and I’m using those to help out people who may want to get into the angel investment or even early stage venture business.

What do you need to be an Angel?

Naval: Basically, to be in the angel business you absolutely have to have three things — to be in the business and to do well. First of course, is access to capital: either you own or you manage to raise the funds or somebody just gives you money.

You need good dealflow and by good dealflow, I mean, proprietary or a high-quality dealflow that not everybody has seen or you have some unique ability to get in to. There has to be some reason why people will take your money instead of somebody else’s. Otherwise at the end of the day, you are commoditized and you get bid out of the game.

Finally, you need good judgment. Access to capital you either have or you don’t. If you don’t have it, then you probably shouldn’t be in the angel business, you’re just wasting people’s time. If you have good judgment, everybody thinks they have, and it takes about 10 years to figure that out so I can’t really help you there.


Naval: So, what I’m mostly going to focus on is dealflow, which is how do you find good dealflow, how do you process it efficiently, how do you get into good deals, how do you evaluate them? When it comes to dealflow, there are a lot of bad kinds of dealflow and there’s some good dealflow. Early on, you will be seeing very few deals and you’ll just be trying to get in the dealflow.

After you’ve made a few investments, you’ve got a few entrepreneurs who know what you’re doing, you have built a bit of a brand, you’ve connected to the other angels you will have too much dealflow, and you will quickly have the opposite problem. If you raise your hand and you say to the world, “I can write a check”, the world will beat a path to your door.

I’m going to help you with an odd problem, which is helping you filter the bad dealflow as well. So, you’re going to get a lot from your social friends, these are the people whose kid goes to school with your kid or someone you just hang out with.

Most of this dealflow, although you should be polite and you should see it, you’re going to have learn how to say no without taking a meeting, otherwise you’re going to find your time chewed up very quickly because these people are not in the business, they don’t have the same filters that you do, and they will pass along anything that looks like a company that’s raising money.

You, yourself, are going to be tempted to do the same thing and forward deals to other angels. Don’t ever forward a deal you wouldn’t do yourself.

Nivi: Or you’re not seriously considering.

Naval: Yes. It’s going to hurt your credibility, and it’s also going to also waste the entrepreneur’s time. The first thing any serious investor will ask you if you, yourself, are an investor and you forward a deal and say ‘”Are you investing?” You don’t want to hem and haw at that point.

You either want to say “Yes, I’m seriously considering it and I’m in the middle of my evaluation process” and you should mean it or you should actually be doing it. Those are kind of the only two legitimate answers.

If an entrepreneur asks you to forward a deal that you have passed on, your best approach is to politely explain to them that, it does not make sense for you to do so as it would send a very negative signal.

Nivi: Yeah, and if you’re an entrepreneur in that situation, I would actually ask for some names of potential investors and tell the angel that just turned you down that you’re not going to use their name to reach out to these people, but you just want to get a list of names to find some other prospective angels to reach.

Naval: Yeah, that’s a very good point. A lot of angels know a lot of other angels, you get a list of names then you have to sift through your own resources and frankly, you browse through your LinkedIn and your Facebook networks. If you’ve been around in Silicon Valleyfor a little while, you can usually find someone who knows someone.

Finally, one issue that crops up a lot when people first get in to investing is, they think they’re going to add their value in some unique process-oriented way, and so they come up with non-standard models. One could be incubation; another one could be acting CEO or so on.

They kind of say, “OK, I’ll put in some money and then I’m going to be super-active, and I want this and that and I’m going to take more stock into that.” I would suggest not doing that. Certainly you can offer it to people you know well, and certainly people can ask you for additional help or these kinds of non-standard deals, but they have two problems.

One is if you end up taking too much equity early on. It makes the company difficult to fund by VCs down the line. Secondly, it will lead to an adverse selection case, where if you’re putting out your services as a rent-a-chairman or a rent-a-CEO, you’re going to see the companies that are so desperate raising financing where they won’t entertain that notion.

Most really great entrepreneurs, yes they could use some advice and they’ll listen to it, but they don’t need you to run their company for them. So be careful about that adverse selection trap and be prepared that with some of the very, very best companies, your only value-add is essentially will be your money plus a few connections and a little bit of advice here and there.

What’s good? Deals that come from other angels who are doing them are usually very good. You build these up by quid pro quo. If they send you deals, you send them deals back and vice versa.

Branding your advisory services is very good. So if you have particular domain expertise, you are the founder of a company that was successful in a certain space, then you should be able to brand yourself in such a way that you will see the companies in your space.

Another way to brand yourself would be through some kind of a horizontal play. If you’re a marketing genius for consumer web companies, then people may come to you for help on that.

Nivi: Yeah. So, here are a few examples of that. The way that Naval put it at AngelConf was Paul Buchheit is the Gmail guy; Naval, himself, is the Venture Hacks guy and he’s also an expert on viral marketing and Facebook, and Paul Graham is Paul Graham. Those are the kind of examples you want to try to follow.


Naval: So, let’s assume you’ve worked out this incredible dealflow pipeline and you’re getting a lot of companies that are coming to you. You want to get through them relatively efficiently. What you will find very quickly is that most business plans, executive summaries are a waste of time.

You can’t sign NDA’s, because doing so exposes you to far too much down the road. So what you really need is very high concept pitch where somebody explains to you, “we are this for that” like an analogy…

Nivi: Friendster for dogs.

Naval: Exactly. Dogster. Maybe a short 10 slide deck. If somebody comes to pitch you, don’t schedule hour-long meetings, you don’t need an hour to figure it out.

Usually within 20 minutes, is enough for the company to get their points across and you should not be pitching yourself at this point. First, you should just be listening; you can always pitch yourself a little bit later.

Nivi: I would say a high-concept pitch, like Friendster for dogs is great. One paragraph, or a couple paragraphs elevator pitch in email form is great, and if the company has it, a 10 slide deck. Of course, more important than any of that is a working demo or screen cast or mock-ups or some realized version of the product.

Naval: Generally, it’s a poor sign if a start-up comes to you, especially if they’re on the web, or consumer web, or iPhone, or one of these spaces where it’s pretty easy to hack something out and they haven’t put together a prototype or they haven’t, as Nivi would point out, made early and meaningful contact with the customer.

Nivi: Which can be done through things like surveys, as well, right? If its offline and it involves hardware or whatever, they could have gone out and talked to the customer via surveys or interviews, or they could have spent the last 10 years of their life working with that exact customer and know them inside out.

Evaluating Startups: Team

Naval: So, now when it comes to a valuable startup, you’ve got the short pitch, you’ve taken the half-hour meeting. There are times when you can eliminate the startup on the basis of team; this is not, obviously, fool-proof. Investing is not a science, it’s an art.

But here are some general rules of thumb I’ve developed over the years, which helped me, filter dealflow. One of those is that usually the optimal configuration for a company, in terms of the founder basis, two to three founders and three is the max.

Five is a very unstable configuration, eventually it will fall apart. You cannot have five cooks in the kitchen.

One is too difficult. The person gets too lonely and it gets too difficult to continue on, because they don’t have a thought partner. So two to three turns out to be ideal.

If you look at the very, very successful companies in the Valley, Apple had Steve Jobs and Steve Wozniak; Microsoft up in Seattle had Bill Gates and Paul Allen and later on Paul Allen dropped out, they had Steve Ballmer and of course, Google had Larry Page and Sergey Brin; even Oracle had Larry Ellison and quickly thereafter had Ray Lane.

So generally, you need teams of two founders at least. You want someone in the company who can build and someone who can sell and if there’s going to be an imbalance; it should, probably, be in favor of the builder.

Of course, it depends on the exact company, but you would rather be investing in a startup that has two builders and one salesperson, rather than have two sales people and one builder.

Generally, you want to say no to companies where the founders are all lawyers or all business guys and they don’t have the product development expertise to back them up or where they are outsourcing the product development completely.

Companies that outsource product development completely, generally have a hard time iterating and keeping up with the changes in the market and the competitors.

One learning that I’ve found the hard way is that is that, especially in consumer web deals, traction matters more than anything. It’s very hard to predict mass consumer behavior. It’s a very efficient market out there.

So, it’s good to find real customer adoption before you put too much money to work, whereas in enterprise deals, where you are selling to a small number of large customers, the team can make a meaningful difference.

Nivi: One thing on the topic of a guy that can sell; it doesn’t have to be your conception of a prototypical salesman or a car salesman or whatever. If you are in a one-on-one meeting with Bill Gates, even though he is a complete nerd, you would be extremely compelled by whatever he has to say to you.

So in that sense he is a salesman, right? A lot of nerds in their nerdiness can actually be extremely compelling in the proposition that they are trying to put in front of you.

Naval: Yes, by salesman, I don’t mean the bag-carrying enterprise sales quota matching guy. It’s exactly as Nivi said, people who are compelling and who can convince early customers to sign up, through whatever means possible. They can convince early employees to sign up when the company has very little cash. They can convince early investors to sign up.

In fact, usually if someone can sell you in an investment meeting really well, and you walk out dizzy, saying I don’t really get the product or this space, but this guy almost sold me. That’s a good sign.

Nivi: Yes, that in and of itself is an asset in terms of being able to sign on customers, employees, other investors, and so on.

Naval: One other thing to think about is when you are evaluating companies at an early stage, the appropriate title for the people in the company is usually founder, or engineer, or things of those sort.

If you see a company that’s very top-heavy, has its CEO, its CFO, VP of this, SVP of that, then it’s usually a bad sign. It means that the people involved are more interested in building up impressive titles for themselves or building a large organization than they are in having a successful product and a good financial outcome.

Nivi: Yes, we want builders.

Naval: In evaluating entrepreneurs, Warren Buffett often says that when he looks at the company he buys, and very often these are multi-billion dollar companies, he’s looking for intelligence, energy, and integrity. I find that the same criteria works extremely well in evaluating start-up founders also.

Intelligence for obvious reasons.

Energy because drive and passion are the number one predictor of an entrepreneur’s success, and it’s not actually intelligence in that case.

And integrity is paramount, because if you have someone with high intelligence and high energy, but they don’t have high integrity, you’ve basically got a hard-working crook. You don’t want to be associated with that. In fact, you prefer lazy, dumb crooks to hard-working smart crooks.

Nivi: Yes. They will have many opportunities to screw you, if they don’t have any integrity.

Evaluating Startups: Customers et al

Naval: So, intelligence and integrity I would not compromise on any of the three.

Similarly, we talked a little bit about teams. Let’s talk about the customers. As we talked about earlier, you don’t want to invest in companies that have made no contact with the customer yet whatsoever.

For an enterprise software company, it might be surveys; it might be a few big customers’ meetings references. For a web company, it usually means the product has been released or some facsimile of it has been released and tried out.

You definitely want to look at a lot of companies, before you make early investments. The usual failure mode for individual angel investors is that they invest too early and too quickly. Part of this is you don’t have a partner who can veto you.

Venture funds are deliberately organized, in such a way that there are a lot of experienced people saying no to the new guy’s urge to go invest in the first hot thing he finds.

In angel fund, I would suggest that you be disciplined either by numbers, so say to yourself, I’m not going to make an investment until I see at least twenty companies. One hundred might not be a bad number. In a busy year, I’ll easily see four, five, six hundred companies.

An even better approach might be to find some experienced angels that you team up with and give them an effective veto. No matter how much you like the deal, if you can’t talk them into it, don’t do it.

Nivi: Yes, and along those lines, you could just say, I’m not going to invest in any deals that these five notable angels are not also investing in for my first couple of companies.

Saying No

Naval: So, saying no is something that you are going to be doing far more often than saying yes. So, let’s get that out of the way. You have to learn how to say no, you have to learn how to turn down people.

It’s uncomfortable, but usually people appreciate a quick and up-front and reasoned no, with some good advice and hopefully a little bit of help attached to it, than they do a dragged out long process where at the end then you hem and haw and have to say no.

So, the best time to say no is before you take a meeting. If some of these deals fail your filters, or if you just can’t see yourself getting excited about the company or the business, say no over email before you meet.

If you hear the pitch, and it is not compelling, take five minutes out after the pitch, talk about it, think about it, and then say no to the entrepreneur before they even leave.

Since angel deals tend to be pretty small, you are investing tens or hundreds of thousands of dollars, you don’t want to drag it out over months. You don’t want to take weeks of the entrepreneur’s time. You don’t want to cause them to generate additional documents or write code just for you.

So try and be efficient about it. Don’t spend more than a couple of hours of their time, or if you had to noodle on it yourself for more than a few weeks, then it probably isn’t right for you.

Warren Buffett makes two really good points. Actually, Ron Conway lists one of them at the angel conference, which was don’t invest in people that you really aren’t excited about working with, because at the end of the day, the business model will change. The details will change. The company’s progress will change.

The only constant will be the person you invested in. If you don’t like to take their phone calls, if you don’t like to sit down there and talk to them all the time, then eventually you are going to see the deal as a burden.

You will eventually run out of time. So, it’s very important that you only pick the people that you want to work with. I just can’t emphasize that enough. It sounds like an easy thing to say, and hard to follow, but in reality, you will find that it will make all the difference in the long term.

The other thing that Buffett points out is that this is a game where the swings that you don’t make are not counted against you.
You just have to find a few hits, and if you let a lot of hits go by while you are waiting for the perfect pitch, that’s absolutely fine. So, when in doubt, just say no.

Since the angel community is very small, the entrepreneur community is very small, your reputation is everything. So, it’s very important that you try and add value to every company whether you invest in them or not.

If they took the time to present to you, and they paid you that honor, then you should take the time to maybe make an introduction or two for them, or give them some useful, honest advice. Generally, it’s not a good idea to try and withhold your capability to help them too much, just because you did not make an investment.

Navi: Yes, and that is where you area of expertise, whether it is raising money or marketing or Facebook or whatever, can really shine right at the end of a meeting.

Saying Yes: Terms

Naval: So, let’s talk about the terms for a moment. So, let’s say you’ve processed a huge amount of deals, you’ve found a company that you want. You’ve said no to the ones that you don’t want. You want to make an investment. Some things to keep in mind is that one of the biggest risks of angel investing is the downstream financing risk.

You may look at a company and say, I could see this being a small but highly likely exit. That’s not initially a great company for you to invest in. The danger there is that a lot of companies use up cash very quickly, they run out of cash. You don’t want to put money after your own investments, because you are obviously now a biased investor.

And VCs always evaluate things in terms of their huge market potential, as VCs have very large funds. It ends up being a little bit of what the economists call the Keynesian beauty contest, which is you pick a winner based on who you think the judges are going to pick to win in the next round.

So, you are not initially picking the most beautiful start-up, you are picking the start-up the judges are most likely to pick. So, it is a dead-end trap to finance too many companies that don’t have the possibility of turning into something huge somewhere down the line.

One way to mitigate that is to co-invest with other venture capitalists. This is where you’re an angel, you’re putting a small amount of money and the VCs are putting in most of the money.

The issue there is that VCs are ownership sensitive. They want to own a lot of the company, but they tend not to be as price sensitive as angels because they have lot of money to throw around. So, one way to mitigate that is to give the VC some different rights that you don’t care about, such as the ability to invest more money the next round, and in exchange keep the valuation lower for you as the angel of this round.

Another opportunity for some superstar angels, or if you are taking a very active role in the company, is you might be able to get a little additional advisory stock, relative to the amount you invested.

Nivi: Just to be clear on Naval’s concern, his concern is that the seed round — that VCs get involved — ends up being for a lot of cash coming in at the high valuation. That makes it economically uninteresting for you as an angel investor, because you will end up owning a very small slice of the company because the valuation will be high.

So his suggestion, if I understand it right, is you basically give the investors — you do the round at a low valuation, you have a reasonable amount of cash coming in, the VCs co-invest, and what you give them is basically an option to invest in the next round. Is that right?

Naval: That’s correct. And in fact, another point of the economics is a lot of first-time angels, especially when investing their own money, tend to invest in what are called “uncapped debt.” So they’re put in a convertible note at a 20% discount to whatever the next round is going to be.

That’s an extremely uneconomic proposition. The odds of a startup going out of business are far greater than 20%, or the 16% that would be required to cover your investment. In fact, there are corporate bonds trading in the public markets today that are yielding 15-16%. So they are far more liquid with companies that are far better capitalized.

Generally, you’re looking for a 3X, 4X, 5X increase in valuation between rounds, which means you are price sensitive. So it’s OK to do a convertible note because that’s often simpler for everybody involved, from a legal perspective. But you generally want to establish a conversion price cap, which pays you back for the risk that you’re taking at this stage.

Nivi: One thing, just going back to the VC thing, from the perspective of an entrepreneur, if I have VCs investing in the seed round, the issue that it creates for me is that if those VCs don’t want to invest in the series A, it makes it very difficult to do the series A, because the inside investors who knows the company best are basically saying the company is not a venture investment.

Naval: One other point about investing with groups. A good reason to invest with other angels, no matter how much you like the company, is that stuff always goes wrong with a startup. And when stuff goes wrong, very often the entrepreneur can make the choice to walk away, especially if the company has a very small amount of money invested.

Or the entrepreneur can choose to do something that would be adverse to you, because you’re a minority shareholder without a lot of the protections that VCs often have. If you’re in a group of angels, you are much more likely to have a good outcome in that situation.

An entrepreneur is much less likely to walk away, if there are five good angels as investors than if there’s only one. An entrepreneur is less likely to change the terms that are adverse to you, if you’re with four other angel investors rather than if you’re alone.

One way in which, if you’re an angel investor, you can squander a lot of time is if you’re board seats. Essentially if you’re taking board seats, you’re going to be limiting yourself to only being able to handle five, six, seven investments, which may not be enough for you to achieve the portfolio affect that you need for the economics to work.

If 1-out-of-20 to 1-out-of-30 angel investments work, and you can only make five because you’ve taken board seats and your time is full, then your economic model is in trouble, and you would have to augment it by sprinkling around a lot of companies where you almost spend no time with them.

Board seats are really only worthwhile taking if you’re getting paid for it, if you have some unique and proprietary insight to the company and it’s market — maybe you started a company in a similar space that did really well — or in that unique case where the company is just someone who is very, very close to you.

Otherwise, realize that boards spend a lot of time on corporate governance issues, which often isn’t the best use of your time.

Nivi: Yeah, I mean, you can simply advise the company. You don’t have to be on the board to advise the company. The other downside is if you’re not willing to leave the board whenever the company asks you to, you can screw up their series A investment, because VCs don’t want to come into a company, which has a random guy who was one of the angels on the board of directors.

Naval: Yeah. It depends on who the angel is, of course.

Nivi: It depends, yeah.

In terms of how much of the company you want to buy, you’re not going to end up with 40% or 50% of the company after an angel or seed round.

You should be thinking more in terms of 5%, 10%, 20%. Capital that is coming into the company is $25K, $50K, $100K, up to $250K, the valuations that you’re looking at are going to be in the $0.5 million to $2 million dollar post-money valuations.

The way you justify the company’s valuation isn’t on the basis that the company is actually worth that much money, in the sense that somebody would buy the company for that price today. The way you justify it and the way entrepreneurs justify it, is through dilution.

You need to leave enough of the company in the hands of the entrepreneurs who are the guys who are creating value for you and for themselves alike, to be incented to create value for the two of you.

If after the first round they own less than half the company, and there are three more rounds of financing coming along over the next five years, they’re not incented to create value for you or for themselves.

So that’s where you end up with the angels or the seed investors owning somewhere between 5% and up to 20% of the company after a seed round.

The other way entrepreneurs justify the valuation is just through a market clearing price. Things are worth what people pay for them, and as long as someone is willing to pay $2 million post money for a company, you have to pay the same price, either if you want to invest alongside them or you want to outbid them.


Naval: So let’s talk about the economics a little bit. Think of yourself as a patron of the arts. If you were in 16th or 17th century Italy, you would be investing in paintings and sculptures. You’re doing the same sort of thing now. You’re not really in this so much to make money, as you are to help the next batch of entrepreneurs get to where you got to.

It’s unlikely that most of us as entrepreneurs would have been successful and gone up in value, without angels as investors, and now you’re giving that opportunity to the next young batch. And I say that because it’s very difficult to make money in this business.

The hit rate is extremely low; the economics are tough because on the really interesting companies it gets bid up by the venture capitalists.

And very often even if you find a hit company and you manage to get a piece of it early on by making and investment, very often you can get wiped out if there’s a bump in the road down the line and you don’t have the capital to pony up.

So think of yourself as a patron of innovation. You’ll sleep a lot better at night, if you assume your investments are lost on the day that you make them. And I’m not the only one to say that. At AngelConf, I think most of the professional angels, including the ones who had been in it for a long time like Ron Conway, made that point.

And your personal portfolio, outside of your angel investments, should be balanced with ultra-safe investments. Nassim Taleb, the author of “Fooled by Randomness” and “The Black Swan,” advocates having a 10% ultra-risky portfolio, in other words, looking for a positive “black swan.” And the other 90% being in T-bills and cash and equivalent safe investments.

But it’s an extremely rewarding business in the sense that you get to work with very, very bright people who are young, full of energy and fire. They show up and they tell you everything they’ve learned about a topic, that they’re deeply passionate about, in a short period of time. So the learning curve is high.

It’s extremely fun, but if you’re not careful you can lose a lot of money and annoy people.

Nivi: I don’t think that I’ve been involved in a company that somewhere along the way was not catalyzed by an angel investor or a seed stage investor. I don’t know if that’s the case for Naval or not.

Naval: I have, but usually the ones that had good angel investors worked out much better. In the angel case, as an entrepreneur, you can get the advice and help and connections that you look for out of a VC but you can get it with much less dilution and much less capital and, most importantly, much less control over your company.

If you’re really looking for good advisors, it’s usually a much better idea to go and get a couple of angels than it is to raise a big VC round. If you need a lot of capital, because you have something that you’ve figured out is working and you want to scale it, that’s when venture investment makes sense.

Nivi: Yeah. One way to think of yourself as an angel is, as basically an advisor that pays for the privilege of advising a company, and in the process gets a little chip in the business, in the case that the company happens to be a Google or a sub-Google like exit, Skype, MySpace or whatever.

Naval: And to echo a point that Paul Graham made a long time ago, the best, highest quality people that you want involved in your startup are usually already pretty successful. You’re not going to be able to recruit them as employees, you probably won’t even be able to bring them on as advisors for small amounts of equity.

The only way that those people will participate in your businesses is, if they have a meaningful stake.

And you don’t want to give huge stakes to a person just for a few words here or there where you don’t know what the value will be down the line, no matter how famous or how successful they are. So the way the market clears is they get to invest in your company.

Venture Hacks

Naval: If you have any questions about this or if you would like to talk more about it, feel free to contact us at We’d also like to know if you’re an angel investor who’s available to invest capital and what your profile is.

So feel free to email us with that and we will try to show you interesting companies. What we would ask is that you tell us how much capital you have to invest, how much you’re looking to put to work, and what your particular areas of expertise are.