Angel Investing- Some Musings
(By R Narayanan, Founder – Nett 10 Digital Ltd
Member of The Chennai Angels)
During most of my more productive working life, I always thought that:
1. The stock market has given a return of approximately 14% compounded per annum over the last 50 years.
2. Banks offered a 10% return which too can be compounded with virtually no risk.
3. Real estate grew over 50 years at > 15% compounded rate.
Frankly, so far as I was concerned, there were alternatives available, and it was best to determine a total capital sum based on what I reckoned would be the retirement income that I desired. I was reasonably assured in my thinking that 10-15% return was and would be always available to see me through my twilight years.
But interestingly, that is no longer the case.
1. Mutual funds are struggling to offer you consistently a return in excess of 10%. Or is it, that as I grow older, I am getting nervous.
2. Banks are not only offering rates of interest of <6% taxable, but one finds that they are no longer the safe haven that they appeared to be. Current policies of the Government suggest that the Government will guarantee only upto Rs 1 lac, and anything above that is subject to market risks.
3. Liquidity in the case of real estate and the constant pressure of land being subject to “grabbing” makes real estate ownership more than a bit of a headache.
Before we launch out more on angel investing, you should be willing to lose money and walk away once you have drawn up your perimeters. Just bear that in mind. That you can afford it and also have the temperament.
I believe it is, although I must confess that I have made a few errors in my angel investments. So, I cannot say with confidence as yet that I will clear the real estate hurdle. But I am an optimist. I think that I will. I need a couple of more 10X exits. But remember I am an optimist.
1.1 Can Angel investing be a comparable asset class in the future?
1.2 Great for thrills
I would say that angel investing is the next best thing to entrepreneuring. Technology developments, and market breakthroughs are thrilling. If you are an optimist with a vivid imagination, then you are already translating your pennies into your share of a unicorn.
Just yesterday that jerk of a promoter was irritating you, but the latest valuation in the (for instance) education game, gives you the belief that luck might turn your way.
If you have 10 investments then you are virtually guaranteed to have 10 cheap thrills every month, If you have a very vivid imagination as I do, then this could be even 15 c-thrills. Sometimes those c-thrills are accompanied by a wisp of a regret that you did not have a more enhanced stake in this particular investment when you had the chance.
And sometimes, realism quickly returns, as you realise that this “idiot” of a promoter will never be able to capitalise on this opportunity. But what goes up must come down and we will revisit this later under “chills”.
1.3 Gives your daily news consumption greater meaning
Every day, your love affair with our beloved Prime Minister waxes and wanes. Inexplicable policy decisions that may or may not help your favorite investments. The PM is throwing a few titbits in the way of startups. Can any of my investees grab the opportunity?
India and China on the brink of war – does my solar investment have adequate inventory of solar panels?
Reliance enters the Fintech business, is my Fintech startup threatened in any way?
1.4 Gives you an opportunity to assess your judgement of people
At the time that you made the investment, it appeared to you that the entrepreneur was mentorable and very clued up. Especially if you were the lead angel, you got to know the entrepreneur quite intimately (at least so you thought) and often started talking on his behalf.
But at that time, the money was yet to be disbursed. Often, there is a huge gap in the conduct of the entrepreneur between before disbursement and after. And then you also see the entrepreneur in a different light. And sometimes, the direction that was promised is not being followed. And when you question this, a degree of prevarication follows; occasionally leaving you with a feeling that perhaps you made a mistake in your assessment.
2.1 Great for chills
When you live and invest in a volatile environment as in India, you have many reasons to feel an occasional “chill”.
First and foremost is the area of adherence to the law. And both in the area of Company law, as well as adherence to the law of the land, paperwork and penalties are quite rigorous. More so, if you are on the board of the company. You carry liabilities that you don’t even know about.
Provident fund, ESI, GST are the first areas of compliance that take place, when there is a cash flow problem. Entrepreneurs are suckers for hiding this information and sacrificing the compliance.
At the time, obviously they think it is temporary. By the time you wake up, the problem is too big to be solved through internal collections.
Incidentally, there are several areas of compliance that can end up with you being personally liable. Both financially and criminally. A matter often ignored by several investors who are board members.
Often you find that deadlines are not being met on fronts that indicate poor execution capability or the intention.
Lack of compliance in the secretarial function will finally surface when you are barred from becoming a board member in other companies. Admittedly, that is another way of discovering non compliance.
2.2 Your judgement of people is being constantly threatened
I have covered this matter already earlier. I bring this back since perhaps the biggest error could be emanating from you.
At the first instance when we find that the entrepreneur has failed you, we are usually looking for a reasonable reason from him as to why this has happened.
And there is a strong bias in our minds that wants us to believe. How could we be wrong in our judgement?
2.3 Be prepared for poor liquidity
All organizations go through periods when they have poor liquidity. Money invariably gets diverted from a budgeted one to elsewhere. It helps if that gets reported at the board level, but is usually not done.
When there is shortage of funds, and if you have provided an introduction to a resource, then you can be sure that payment to that resource will be one of the early sufferers.
And when you bring it to the attention of the entrepreneur, usually he will act as though he was unaware of it and will promise to look into the matter.
I have a simple formula to ensure that you are able to nip such issues in the bud. Once is an accident. Twice is coincidence. Thrice is a pattern. And this does not refer only to cash flow situations but across all situations where trust is being breached.
3. Do and Don’t
3.1 Join an angel group
You get the wisdom of crowds. You get the wisdom of specific individual investors for whom you have great respect.
3.2 Have a ceiling on the total investments to be made in this asset class
Just for example you could have a range of 5-10 lacs on your first 5/6 investments. You would not exceed 10 lacs especially if your total risk investment is only 1 cr max into angel investing.
Which means that until you start seeing returns you will not go over the limit. I am not prescribing limits, I am only elucidating through examples.
Having said that, it might well take over 8 years for you to recover your 1 cr., if at all. And it is best to have at least 12-15 investments before some of them start paying you. 1 cr across 1/2 investments is not a good idea.
Lastly, remember that most worthwhile investments will come around for a 2nd round from the angels before they take off. You must reserve some money for that.
3.3 Don’t get carried away with your own IQ, and break your own previous self imposed rules of ceiling and range
Every now and then, you come across a project that seems an outright winner and which can potentially pay you back multifold.
Because you like the project so much, you will find the entrepreneur very exciting and seemingly competent.
And you feel that it is time to break the shackles of self imposed limits and place 25 lacs in this startup.
3.4 Don’t provide off balance sheet loans
Since you have been an entrepreneur yourself, and since you are a close advisor, you are an obvious soft touch for a loan. Not a good idea, to provide the same.
3.5 Do not Overcommit yourself in assisting the entrepreneur
Putting your money behind your mouth or vouching for an entrepreneur are both instances where you are putting your reputation on the mat. Think of both in an identical manner.
Too often we end up vouching for people who are quite dishonest in terms of values.