Angel Investing: Insider Secrets to Wealth Creation

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Introduction

An Insider’s Overview

The reason angels can fly is because they take themselves lightly.

—G.K. CHESTERTON

‘WATERSHED MOMENT,’ SAID the TV anchor about the Walmart–Flipkart deal.

‘Retailing landscape is likely to change,’ said a panellist on this special show.

‘What is there to be happy about? One company is acquiring another. Almost every company in this space is losing money. So, what is the big deal?’ asked another.

The discussions continued.

What was the big deal about?

American retail giant Walmart acquired the Indian company Flipkart in 2018 in what was then the world’s largest ever e-commerce deal. Walmart paid $16 billion for around 77 per cent stake in Bengaluru-based Flipkart. This deal catapulted Walmart into India’s growing e-commerce market, estimated to be over $200 billion by 2026, with the likes of Amazon already present.

Investors and founders of Flipkart made some serious money. The media continued to churn out the related stories for a while—were the Bansals, that is, Sachin Bansal and Binny Bansal, the co-founders of Flipkart, winners for making a billion dollars for ten years of work? Or did they actually lose out by having to give up their company? Would this deal create a cascading effect on other local companies? Will start-ups regain their sheen? Will the capital tap open again? Will more people venture or invest in start-ups? The debates go on.

In this entire hullabaloo, an interesting fact surfaced about the role of Ashish Gupta. In 2009, Ashish had invested ₹10 lakh in Flipkart, a start-up based in a leafy suburb in Bengaluru. Flipkart was into selling books online; trying to emulate Amazon in India. Its co-founders Sachin and Binny Bansal had worked with Amazon in the US, before venturing out on their own to start Flipkart. Ashish saw Flipkart’s potential. He backed Sachin and Binny, and stayed the course through several ups and downs. Ashish was an angel investor in Flipkart. He made more than 1,300-times returns when he sold his stake to Walmart in 2018 for about ₹135 crore. For some, this can mean life-changing gains.

An angel investor, also known as business angel, informal investor, angel funder, private investor or seed investor, is an individual who provides capital for a business start-up in exchange for a stake in the company.¹ The capital is in the form of equity or some form of debt or a mix of both.²

THE SUCKER AT THE TABLE

Angel investing in India is more than a decade old. It has grown dramatically from a few investors to a sizeable community. It is here to stay and grow. Over the years, there has been some professionalization of this investor class. Syndicates or angel groups have emerged. What started off as a small group in Mumbai with an idea to bring home the Silicon Valley ecosystem has now spread across key cities all over the country. Some angel investors play the game with OPM (other people’s money) and with bigger stakes—a heady concoction. Government policy and economic optimism aid this game. Many more people are expected to enter this arena with the hope of making money. Many expect to make life-changing money. This is probably a good time to caution that angel investing is not as easy as it appears from the outside. It isn’t an easy ride. It is more than simply investing and making profits.

Usually, the talk is about returns alone, not the accompanying risks. The reality is that this is a tremendously risky activity. Many of my angel friends, all of them astute investors, and bright and connected people, speak privately about how they have invested in several ventures yet, have very few profitable exits. None of this is discussed in public. The mainstream media highlights big deals, big cheques and big names. This creates false perceptions. Some investors, with one or two successes, start believing that they have a divine gift to spot winners. Unfortunately, that is not true.

Such talks build false perceptions. Many people mistakenly believe that it is easy for anybody to turn up and make money. It isn’t. Very few make money. This game is stacked in favour of such select few. There are a few seasoned players and many suckers. If you don’t know who the sucker at the table is, it’s probably you.

SO, HERE’S THE ZILLION-DOLLAR QUESTION—WHAT DOES IT TAKE TO BE A WINNER IN THIS GAME?

The first requirement, quite obviously, is access to investment opportunities or deals. Many people think that they have access to quality entrepreneurs and deals, but this couldn’t be further from the truth.

Many successful start-ups are launched by ex-employees of other successful start-ups. Ex-Amazon folks started Flipkart. In fact, ex-Amazon employees have launched more than thirty start-ups. Similarly, ex-Flipkart folks have launched about seventy ventures. InMobi has spawned more than forty start-ups. Look at the earlier generation of entrepreneurs and companies. People from Wipro and Infosys have each created more than 500 companies, mostly in software services. Globally, the ‘PayPal mafia’ is well known. These ex-PayPal employees have built billion-dollar companies, such as LinkedIn, Palantir and Tesla. You get the drift—don’t you? Successful start-ups spawn many more. Quality deals are not easily accessible.

People who cut their teeth at successful companies use their experience and insights to strike out on their own. Their first call is often to their existing networks, including early-stage investors, entrepreneurs and colleagues. Do you have access to such entrepreneurs and deals? Unlikely, if you are a common investor or professional.

Angel groups provide access to many deals. However, being a part of an angel group does not guarantee success. At times, it can be counterproductive. The group interactions can lead to groupthink. Having famous names on the investor list can tempt you to join. This can lead to wrong actions like paying more than what you originally intended. I recollect the story of a mobile technology and services company. It generated great excitement among angel investors. Some investors struggled to decide whether to invest or not. So, to get a better understanding, we met the promoters once again. We visited the company’s business partners. It was clear why the deal was hot. The company operated in mobile technology, the flavour of the season. It tapped consumer-goods channels. It was a rare conflation of consumer and mobile play. This explained the investors’ interest.

We tried to evaluate the long-term potential, particularly with the impending disruption in technology and consumer behaviour. We were unable to figure out where the company would be a few years from then. Yes, it had a decent business model. It was poised to grow. It could even earn profits in the near term. Yet, it was difficult to ignore the question of long-term viability. The company could justify its initial numbers, but the overall narrative was weak. Some of us opted out, though the deal was oversubscribed many times.

The company rode on investors’ excitement and herd behaviour. It raised more capital than what it had originally asked for. A general sense of optimism pervaded.

The performance in the next few quarters was superb. The company delivered good results. It made news. Soon, it was ready for next round of growth capital. It was in a sweet spot to attract the VCs (venture capitalists).

The VCs came on board. The company quickly grew its revenues to ₹100 crore. Life was good. Then the VCs invested more capital and started playing a bigger role in running the company. More capital was deployed to purchase growth. Profitability took a back seat. Cash was relegated further back.

This heady growth, fuelled by investors’ money, brought irreversible changes in the company. The earlier core culture changed. Originally, the company was built on simple middle-class values. It had strong focus on cash. With large capital flowing in, this mutated into partying hard at luxury hotels. Growth became the only mantra. The company undertook expenses for anticipated growth. In such situations, if the actual growth is a little delayed or lower, it can hit the financials hard. And it did. Losses mounted to more than ₹100 crore. The risks to the company became obvious. The VCs developed cold feet. Funding became a trickle. In no time, the company folded up, leaving dead angels in its wake.

Capital is not a panacea. Too much of it can spur undesired behaviour. Companies can die of indigestion as much as by starvation. Chasing mere growth isn’t enough. Long-term viability is critical too.

As an entrepreneur, you need vision, a clear narrative and a broad plan to translate vision into reality. You need to carry others with you. You need to inspire people to scale seemingly unsurmountable peaks while taking firm steps to ensure the basics.

As an angel investor, you need empathy to support the venture through its roller-coaster ride. You need to be able to help the company perform better. Can you connect with companies for partnerships? Do you have connections at the right level, say at the CEO or the head of product management? Can you connect with other business leaders and get them to mentor your companies? Can you tap your network to attract talent? Can you influence execution? Can you inspire better performance? Can you build a brand?

In addition, you need the ability to connect with the next line of investors like VC and PE (private equity) funds, strategic investors including corporates, product companies and money bags—anybody who offers growth capital. Can you call up such investors? Can you initiate the next round of investment?

If your answers are ‘yes’ to these questions, then you are invaluable to entrepreneurs and their ventures. Top investors bring many of these skills to the table.

Good investors are generally well connected. They help their network and get reciprocated. They add value. They are a good sounding board. They help build businesses. They think long term. They are aware of lady luck, yet focus on doing right things. They prefer working than waiting for luck to create opportunities. Such investors are rare. Many others just try their luck. They ride the momentum and look at early-stage investing merely as a financial activity. It is not uncommon to hear investors, and bright ones too, saying ‘mera dus le lo’ (take ten lakh from me) during social interactions. They often invest simply because a famous lead investor has signed up. They are neither concerned about nor willing to understand the nuances of the business.

This lazy approach to angel investing can be disastrous. Successful angels usually have a portfolio of ventures. This portfolio delivers a few great outcomes and some other not-so-great outcomes. Unless, you are mimicking the entire portfolio, as part of your coat-tailing approach, or you are extremely lucky, your investment performance is likely suboptimal.

Mimicking an angel portfolio is next to impossible. Luck cannot be your strategy to succeed, especially in early-stage investing. Yes, luck is important, but luck alone is not enough. You need skills—some domain expertise, some specific capability—which you can use to create value. Unfortunately, many tend to overrate their capabilities. They may have a general sense of what is going on but not well-honed knowledge to appreciate the nuances of the particular business. It is the difference between a cricket player with hundreds of matches under his belt and a commentator.

One important thing I have learned while being an investor, going through hundreds of pitches, working alongside entrepreneurs, sitting on boards and evaluating key decisions, is that there is a massive difference between perception and reality in the world of start-ups. Many consider angel investing as a joy ride—a mere financial activity, which can deliver life-changing profits when lady luck smiles at you. It isn’t. Angel investing is far different from a casino. It requires lot more than lady luck. It is about identifying the right opportunities, investing and inspiring companies to grow and succeed.

Access to deals, connections with next line of investors, domain knowledge, desire to help others, and empathy are important ingredients to improve your chances of success. But, to really get started, the most important requirement is money—the more, the better. So, unless you have enough money to put at risk, don’t get into this game. Without money, you cannot be an investor. Money is critical not only to enter the game, but also to play further in the game. The amount of money you have determines your approach to investing. Innumerable things can go wrong. The venture may not generate cash as expected. You might be required to invest. You might be required to invest further to help the company navigate a rough patch. Some investments may even turn sour. To counter such losses, you need to diversify, that is, do more deals and not put all your eggs in one basket. Investing in more deals instead of just a few improves the odds of your success. Investing in one or two deals merely to try your luck is not worth it. More deals require more money. Even a positive result of your investment might require you to participate in the next rounds of funding to enable growth. You don’t want to miss such opportunities.

How much money you have and how you manage it defines your investment approach. At one end, you can start off with a few lakh of rupees, invested judiciously and backed up with capability. There are many who start off with as little as ten lakh rupees. They invest in one or two ventures and spend substantial time and energy on the companies they invest. They are more like entrepreneurs. They bet more on capability than capital.

At the other end, you can start off with a large pool of capital and invest in many deals. ‘Spray and pray’—that is, invest in many ventures to diversify risk and hope some will succeed. Many try this approach. Usually, they have deep pockets. They have good access to deals. They are more like money managers engaged in diversification and risk management. Even if a few of their investments do well, these make up for the entire capital invested, for the losses elsewhere and yet deliver good returns on the overall portfolio. In most situations, the game is played between these two different approaches—one which bets on capability and focus and the other on financial diversification and luck. The game is exciting. It offers the thrill of participation in this increasingly popular start-up ecosystem. Being successful in this game is not about the number of investments. It is about the quantum of right investments.

Unfortunately, there aren’t many early-stage investment opportunities where you can deploy large amounts of capital. Besides, doing so is risky. Opportunities to invest large amounts come when businesses grow and require growth funding. Money deployed in such opportunities can produce wonderful results. You would have a better risk-reward profile here, as you would have been with the venture since its early stage and have a good grasp of the risks. You would have clarity about the opportunities. You would have an insider’s understanding of the plans. Clearly, the odds would be stacked in your favour.

Grab such opportunities. If you have confidence about the company’s growth and durability, participate in funding. Increase your stakes. If you have no confidence, exit. In other words, bet more on the winners. Eliminate the flops. If you neither invest more nor exit, you end up with sub-optimal outcomes. You run the risk of being crushed by the VCs, who invariably show up when ventures begin to succeed. The VCs can have punishing terms, with rights and preferences tilted returns in their favour, particularly against those who are not participating in the funding round. In such situations, what is your protection? It is only money. Money enables participation. It helps you to seize opportunities.

Many people ask, ‘How much money is required to enter the game?’ This depends on your ability to add value, your appetite for risk, your skills and your network to arrange capital from the next line of investors.

Start off by deciding how much money you are willing to lose. Nobody wants to lose money, but usually there is a basic amount that would be painless, though annoying to lose. What is it for you? This is the amount to start with. Often, this is a very small percentage of your total investible corpus. Your comfort generally increases with the depth of your pockets—with a large corpus there is less pain in losing a small sum. An interesting way to account for this is, as they say in Marathi, ‘akkal khati jama’, that is, credit the amount of ‘akkal’ or sense or wisdom you gain from your investing experience. In other words, you write off the loss but gain in wisdom. Some angels believe that they are in this game to learn and to help entrepreneurs get a break; like they once received themselves, and that they are a part of a larger karmic cycle. Some are less philosophical. They tell themselves and their wives that the money is simply lost. If the planets align in their favour, it may come back.

Being an angel is a journey. Start your journey whenever you feel you are ready. Experience teaches several invaluable lessons. Start off by learning from the experiences of others. This book can help. It draws from the experiences of both investors and entrepreneurs. It offers you a ringside view of the ecosystem which has all kinds of players. Some of the more colourful ones are:

The Cheque Writer: She has money bags as a competitive advantage.

The Mentor: She invests capability more than capital.

The i-Banker: She helps in raising capital for a fee.

The Corporate Funds: They are in the game to keep abreast of what’s going on. They make a few, selected investments in specific domains. They are keen on tapping talent.

The Incubators and Accelerators: They provide initial infrastructure and assistance to entrepreneurs. They help in starting up. Some help in raising capital too. Usually, they take equity as their fee.

The Micro-VC Funds: They are mostly managed by angels and play the game on a bigger scale, with a higher risk appetite, using OPM.

The Crowd Fund: This comprises people who participate with smaller amounts of money individually, but collectively provide larger capital to early ventures. They are like the public markets—they bring together hundreds of unknown, unrelated participants to provide start-up capital.

The SME Stock Exchanges: These have been launched by both BSE and NSE for small enterprises. They offer a good platform and opportunity to raise public equity.

The Impact Investors: They invest for a broader social cause rather than just to promote entrepreneurship or to make money.

Next in this ecosystem are venture capital (VC) funds. Following VCs are private equity (PE) funds. Both VC and PE funds come in several hues. Lastly, you have stock markets—the ultimate source of equity capital.

Being an angel can be exciting, but not easy. To be successful, what really matters is a) How skilful you are at judging potential and b) How benevolent you are to ventures.

In 2008, I met Hitendra Chaturvedi, an entrepreneur. It was the peak of the Mumbai monsoon, just after the global financial mayhem. Lehman Brothers had come crashing down. The sub-prime crisis was threatening