The Wisdom of Crowds of Angel Investors

July 7 2011 8 Commented

In 2004 James Surowiecki, New Yorker business columnist, wrote the Wisdom of Crowds which recognizes that the opinions of groups is routinely more accurate than those of most individuals in the group.  In particular, the author demonstrates that large crowds consistently outperform experts within the group in decision-making.  I sense that the Wisdom of Crowds defines a winning strategy for angel investors, especially those who are members of angel funds. 

Angel investors invest time and money in seed and startup companies.  Since the mid-90s, many angels have discovered the efficiency of investing as part of an angel group.  There are two types of angels groups (see Models of Angel Organizations):  Networks in which member angels screen and scrub deals together and then make individual decisions to invest for their own accounts.  Angel funds, on the other hand, pool their monies in advance, screen and scrub deals together and then vote on making an investment from the fund.  The Frontier Angel Fund (Kalispell) is an example of an active angel fund and one for which the strategy suggested by the Wisdom of Crowds might be quite useful.

To quote Surowiecki, “Diversity and independence are important because the best collective decisions are the product of disagreement and contest, not consensus or compromising.  An intelligent group, especially when confronted with cognition problems, does not ask its members to modify their positions in order to let the group reach a decision everyone can be happy with.  Instead…the best way for a group to be smart is for each person in it to think and act as independently as possible.”

Surowiecki’ s message for optimizing returns in angel funds is that members need to be as independently informed as possible on each deal, debate the pros and cons of each investment and then vote to make the best collective decision.

8 Responses to “The Wisdom of Crowds of Angel Investors”

  1. Frank Peters says:

    Bill, before I joined an angel group I was investing on my own – that was scary because I was deprived of the insights of other angel investors. Joining Tech Coast Angels was a great comfort to me; I would eventually make better decisions, and more of them. So I am a big believer in the Wisdom of Crowds. One more example: my latest investment, my 20th with TCA, was a deal I heard of late in the process, but because there were 50 interested fellow members I decided to jump in, too. I only read the first paragraph of their application; I didn’t need to know much more than it came from our esteemed San Diego Life Science track and that there would be many other investors in the deal when the company comes back for more money. Just following the herd? Some will say yes, but for me it’s the benefit of the Wisdom of Crowds.

  2. admin says:

    Thanks, Frank. As you know, I too am a huge advocate for angel groups! Bill

  3. While I agree with the end applicable advice, I believe the wisdom of crowds is more applicable in some situations than others. Where it is less applicable is where the decisions require moving to the fringes of normal opinion or breaking from conventional wisdom. Crowds pull you back towards center, not push you to extreme positions. I think angel investing requires (sometimes) moving to the fringe. This is where some of the high risk / high reward opportunities will exist. Crowd-wisdom will make collective investing safer overall, but will also likely push out some wonderful opportunities.

    Jamie Flinchbaugh

  4. admin says:

    Thanks, Jamie-
    Your analysis is surely appropriate for consideration of angel investment in a single startup company. The advantage of the Wisdom of Crowds is probably in portfolio returns. To assure a reasonable retiurn, angels reduce risk by investment in many companies (10 minimum while 25 may be optimum).
    Bill

  5. Ivan Miller says:

    “Diversity and independence are important because the best collective decisions are the product of disagreement and contest, not consensus or compromising. An intelligent group, especially when confronted with cognition problems, does not ask its members to modify their positions in order to let the group reach a decision everyone can be happy with. Instead…the best way for a group to be smart is for each person in it to think and act as independently as possible.”- Surowiecki

    I have believe in this wisdom since I started my business. I hope a lot of people especially the starters would actually apply this one.

  6. Paul Silva says:

    Bill, how much have you played with prediction markets as a tool for screening? I ask because we ran an experiment through ACA and got some fun results. It is making me wonder if there are ways to expand it. Is this something you have looked at or know anyone else who is? Thanks.

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  8. Bill Payne says:

    Thanks, Paul – I have thought about the Wisdom of Crowds strategy as a direct screening tool for a couple of years. While I think angels groups do tend to indirectly use this tool, we probably rely too much on our perceived experts, rather than encouraging a true crowd strategy. If you have had some interesting experiences, I’m sure we would all like to hear abou them – here or at the next Angel Capital Association meeting.