Angel Investor Portfolio Strategy

May 12 2010 No Commented

Angel Investor Portfolio Strategy

In an earlier post, I addressed the issue Is a Respectable ROI an Achievable Metric for Angels? and concluded that, under certain conditions, reasonable returns could be achieved from an angel’s portfolio. My conclusions were based on a study by Professor Rob Wiltbank at Willamette University (near Portland, OR) Returns to Angels in Groups. Please allow me to elaborate on my earlier work to provide an example of what might be expected from such a portfolio.

In a hypothetical scenario, let’s assume an angel invests $100,000 in each of ten companies in one year (total investment: $1 million). Then, let’s assume that returns mimic the Wiltbank Study, as follows:

  • At the end of year three, five companies are out of business. Three total failures and two each returned ½ the invested capital (total return: $100,000 from these five).
  • At the end of year 4, four additional companies had positive exits of: $100,000, $150,000, $200,000 and $300,000.
  • At the end of year 6, the remaining company returned 20X to investors, $2,000,000 – a real home run.

 Note that the first nine companies returned only $850,000, less than the total capital invested for all portfolio companies ($1 million). All the upside return on investment came from the single home run investment in year 6.

The internal rate of return (interest rate) for this portfolio is 28% per year. The cash-on-cash return (return on investment = ROI) is 2.85 times invested capital. The skewed returns from this hypothetical portfolio, with a single investment providing all the upside and the timing of returns, closely simulates the results of the Wiltbank Study referenced above.

So, what can we conclude from the Wiltbank Study and this simulation?

  1. Angels need to have a portfolio of more than 10 companies to assure some chance of success. Fifteen is probably a better number.
  2. All investments in an angel’s portfolio should demonstrate the possibility of scaling to at least a 20X return (since we cannot predict which will be the winners).
  3. Don’t attempt to measure success until year six or later. Lemons rot faster than plums ripen!

 It’s a GREAT time to be an angel. Find a group and jump in!

Bill Payne is the 2010 BNZ University of Auckland Business School Entrepreneur In Residence.