(and how to avoid them)
Angel investing is a tricky business.
Startup investments are high-risk high-reward opportunities and anyone that deals in them has made their fair share of mistakes.
However, there are a few common mistakes beginner investors make again and again that are so easily avoidable.
Luckily, you don’t need to fail to learn these mistakes—you just need to read.
Here are the top five mistakes angel investors make and how you can avoid them.
Mistake #1 - Investing in ideas instead of people.
I always say—angels invest in people, not products or ideas.
A great idea means nothing without great people behind it. Teaming up with a strong founder is the first step towards angel investing success.
According to Noam Wasserman, Harvard Business School Professor and author of “The Founder’s Dilemma,” 65% of startup failures are a result of founder conflict.
That’s two-thirds of all startup failures. If two-thirds of startup failures are the result of bickering founders, that seems like a major priority for investors!
People can make or break your investment.
To lower your risk, always look for outstanding leadership in the company. Leaders with track-records of bringing startups from inception to profitable liquidation are always your best bet.
When conducting due diligence, ask yourself:
How long have the founders worked together?
Have they had previous success in the startup world?
What obstacles have they overcome so far?
And while founders come first, the entire founding team is essential to your investment’s success.
The team doesn’t just operate the startup, they bring their networks and communities into the mix. These networks don’t just act as a pool of knowledge, connections, and talent to pull from, but they will also become the early adopters and evangelists of a startup’s products.
Finally, the other person you should be investing in is the lead investor.
This investor doesn’t just fund the startup—they guide it. The lead uses their knowledge and expertise to push the startup to a successful exit.
They work on your behalf, ensuring that deal terms are fair and representing shareholders in votes that shape the future of the startup.
And because the lead investor’s only incentive is to earn a large ROI for themselves, you can be confident following one into battle. Their success is your success.
So, if you want to find a home-run startup, look for an all-star lead.
Solution: Focus on the founders, the founding team, and the lead investor first. The idea, tech, and financials come second.
Mistake #2 - Getting caught up in buzzwords.
If you feel yourself being roped in by startup jargon, it’s time to get serious and see what substance lies behind it.
You never want to find yourself enamored by a backstory or by the scope of an idea before getting into the nitty-gritty.
Market analysis, financial goals, and transparency are much more important than what’s trendy and exciting.
Don’t trust in the use of buzzwords—skim over headlines and get to the meat of the story.
For example, the term “disruptive” gets thrown around a lot in the startup world. Nearly any company that claims to do something unique drops this word into pitches and marketing material.
You will see the terms disruption and innovation used interchangeably. This is misleading. If you want to invest in truly disruptive startups, it’s important to know the difference.
Disruption begins at the bottom of a market, or an entirely new market, with a low-end product or service. Disruptive innovation is affordable, accessible, and valuable to consumers.
Long story short, if it doesn’t lower gross margins, target small markets, and offer simpler solutions than their competition, it isn’t disruptive.
Don’t let the use of buzzwords fool you into thinking a startup is doing something that it’s not.
Solution: Check your expectations at the door and stick to hard facts.
Mistake #3 - Forgetting the product-market fit.
Product-market fit is the most important thing for a startup to get right. And, it's the most important thing for you to identify before investing.
Product-market fit means being in a viable market with a product that can satisfy that market.
While this may sound obvious, it’s far more elusive than you’d expect. Most startups will never find their PMF.
PMF comes only after several essential milestones have been met. It’s the result of loads of planning, testing, and validating. It isn’t an idea or a value, it’s a position.
This is where it gets tricky for angel investors.
Early-stage companies will seldom have a product-market fit. Your job is to assess the company and make sure that it's on track to reach it.
Many companies you will study will have great teams and innovative ideas but simply cannot connect the product to the market. They may not even realize that they have no market.
The only way to get a product-market fit is to target an underserved market and bring to it a product with a strong value proposition.
Here are four questions to ask to help you decide if a startup is on its way to a product-market fit or not:
Is its market clearly defined?
Does its product solve a problem for that market?
Has the product been tested on customers?
How do customers respond to the product?
The better these answers are, the better the chances of the startup’s success.
If these questions aren’t being answered, the company will never reach a product-market fit and isn’t worth investing in.
Solution: Ignore “innovation for the sake of innovation” and only invest in startups that solve a problem for a specific market.
Mistake #4 - Putting all your eggs in one basket.
If you invest in just one or two startups, you will never build a sustainable portfolio.
One angel investing success can pay for ten or more new investments, but finding that success is difficult.
The rule-of-thumb strategy for angel investing is to have many startup investments active at any given time, at least ten if not more.
By spreading out your capital across many startups, you allow the numbers to work in your favor. Doing this, you greatly increase your chances of landing an exit on one of your investments, which will return 10x, 30x, even 50x your initial investment.
With that fresh capital, you can reinvest into the private markets and grow your portfolio. This is the best strategy for building wealth as an angel investor.
Another thing to consider, the quantity will give you some inherent diversification, but it is important to focus on other dimensions as well.
You can diversify your startup investments by investing in:
Startup in different industries
Startups in different stages of development
Startups led by different types of entrepreneurs
Startups taking on different types of risks
Through diversification, you mitigate risk.
For example, if you had invested heavily into the hospitality and tourism industries in 2019, your portfolio would have tanked when COVID-19 struck.
However, if you had split your investments across hospitality, healthcare, cybersecurity, and consumer products, your losses would be dampened. With that level of diversification, you could have even turned a profit.
Likewise, by investing in some early-stage startups and some developed ones, you will have an even spread of returns over time.
Some returns will come in three years, others after five, and more still after seven.
With this strategy, you can “flip” your profits back into investments steadily, rather than waiting for everything to happen at once.