While venture funds are reducing business activity due to the crisis, business angels are enhancing their impact on the venture ecosystem.

According to Eleanor Warnock of Sifted, angel syndicates today have more capital than ever. Thus, the German association 10x Founders raised €160m for joint investment, which is not the limit.

Yesterday's IT entrepreneurs or top managers taking their first steps in venture capital investment can join a syndicate or work with appealing startups one-on-one. Whatever the scenario, it is vital to allocate the available capital wisely.

This article tells you what you need to know to build your first portfolio.

Determine the value you can propose

First, having millions in your account is unnecessary to start investing in startups.

One of the easiest ways to try this role is to offer the founders your time, expertise, and network in exchange for a small share, from 0.1% to 1%. Read more about this in the article: More Independent, More Nimble: Invest as an Operator Angel.

In this case, the flow of deals is determined by the network, area of ​​competence, and the amount of free time of a promising business angel.

Reduce risk by allocating capital

If capital is present, then there is something to lose. Those investors who put all their eggs in one basket are more likely to be at risk. According to Marianne Hudson, angel investor and chief executive of the Angel Capital Association (ACA), the more companies you have in your portfolio, the more likely you are to have a reasonable rate of return.

However, the “spray-and-pray” diversification approach can lead to lower overall portfolio returns. An independent angel needs as many transactions as he can check qualitatively and comprehensively. Dan Rosen, chairman of the Angels Alliance in Seattle, whom Hudson refers to in the article, believes that the optimal number of companies in an individual's portfolio is between 12 and 30.

At the same time, Dave McClure, founder of business accelerator 500 Startups and successful angel investor, claims that only 1-2% of startups ever reach Unicorn status. That being so, an investor who expects to significantly (x50) proliferate his investment must have at least 50 companies in his portfolio. Otherwise, the chance of meeting a super-successful startup along the way is close to zero.

Today, venture investments are undergoing a gradual democratization process. Typically, this indicator can be achieved with a capital starting at €50k — by investing one thousand per project over a 1-4 year period.

In addition to the total investment, there are other ways to manage risk. For example, you can balance your portfolio by adding projects across industries, geographies, and business development stages.

If you prefer to stay afloat, look for like-minded people

A Journal of Business Venturing study argues that the most productive work projects with various industries are achieved through networks of joint investment. 

The authors examined a two-year data set of 142 business angels who invested in 65 companies from 34 sectors of the economy. The study found that investors with access to specific knowledge through their central position in a network of industry professionals tend to perform better at higher levels of industry portfolio diversification.

The relationship between industry diversification and performance: a three-level model. Source: Journal of Business Venturing

One of the most obvious ways to find more experienced associates is to join a syndicate or business angel club. You can also copy trades of advanced investors on the Uniborn platform to feel more confident when taking the first steps.

How to choose the proper structure for a joint deal can be found in the article Angel Investing via SPVs VS. Micro-Funds: how to choose the right structure for your syndicate?

Be ready to add fuel to the fire

It is more than just getting involved in a successful project on time. Equally important is the ability to maintain it in the process of growth.

By dividing the amount intended for investment in a particular startup into two or three rounds, the investor not only gets the opportunity to observe the dynamics of its development but also reduces the risks in case the team falls apart.

If the project thrives, subsequent rounds with the participation of the angel will provide him/her with more favorable exit conditions.

Define project selection criteria

Extravagant angels and even entire venture capital funds manifest a super-narrow focus and only talk to startups that are part of it. However, most beginner angels are free of strict limits and rely on common sense.

For its annual Venture Barometer 2021 study, Barometer polled dozens of business angels to find out what criteria they use to select portfolio startups. 

Respondents noted the three most important, in their opinion, characteristics:

• 68% noted the experience of the team;
• 60% — growth rate;
• 53% — project market volume;
• 30% — project article;
• 20% — development strategy.

The essential characteristics, in addition to the indicators of the project, the angels named:

• 78% — personal qualities of founders;
• 58% — investor understanding of the subject area;
• 53% — a comment from a reputable business angel;
• 43% — the presence of a reputable fund in the transaction.

Most respondents are ready to consider from 3-4 startups per month (25%) to 1-3 per week (48%). It can be a benchmark for beginners.

Determine the risk level

A venture capitalist always takes risks. Therefore, stress resistance is so vital for up-and-coming business angels.

However, there are more and less conservative approaches to portfolio formation. William H. Payne, active business angel and member of the Kauffman Foundation, gives the following breakdown:

📗 A very conservative angel portfolio:

• $25,000 per investment x 2.0 (a reserve of 100%) x 15 investments = 10% of net worth
• Required cash = $7,500,000
  

📙 A conservative angel portfolio:

• $25,000 per investment x 1.50 (a reserve of 50%) x 12 investments = 15% of net worth
• Required cash = $3,000,000
  

📕 A less conservative angel portfolio:

• $25,000 per investment x 1.35 (a reserve of 35%) x 6 investments = 25% of net worth
• Required cash = $1,000,000
  

However, today, with the advent of many tools and platforms for the interaction of angels and the exchange of experience, the situation may look somewhat different. Therefore, in the following articles, we will discuss different approaches to calculating the expected return.

To learn more about how to start investing in startups, check out this: Want to start investing in startups? These five books will save you years.