Most investors ‘come of age’ learning the mechanics and strategy of investing through their involvement in stock markets. That makes sense: stock markets are typically comprised of the largest and most stable companies within a geography, with enough interest that investors can relatively easily buy and sell shares. Individual shares and mutual funds populate many long-terms investors’ retirement portfolios. And it’s the stock market, we’ve always been told, that deserves investors’ dollars and attention.
But as new technology enables investing in newer, different types of assets, stock market investors are beginning to look beyond just investing in the stock market and more towards investing in alternative assets: like real estate, commodities, and more often, startups.
How stock market investors evolve to angel investors
So, how’s a stock market investor to invest in startups? How do stock market investors transition successfully to becoming an angel investors?
Here’s how investors with experience in stock markets should best think about investing in startups:
Diversification is a key concept in investing and whether you’re a stock market investor or angel investor, diversification is going to impact your investing results. At a high level, diversification is the only free ride we have as investors: by not putting all our eggs in one basket, we not only lower the risk in our portfolio – we actually improve our performance. This is backed up by some (pretty intense) math as part of the Modern Portfolio Theory.
Angel investors also have to deal with risk. But for angel investors, the issue is more acute. If 3 out of 4 startups fail, managing risk becomes paramount for someone investing in startups. As opposed to investing in publicly-traded securities which rarely flop, startups have a much higher attrition rate. Experienced angel investors understand the portfolio dynamics unique to this asset class: typically, a handful of their investments fail, a few have small returns, and just 1 or 2 have such large, out-sized returns that they pay for all the losses (and then some). The data show that to get those sexy returns that headlines boast of (2.5X over 4 years), you’re going to need to invest in at least 10-15 startups. Returns continue to improve with angel portfolios of up to 50 investments. We call this the portfolio approach to investing in startups.
Long term returns
The long term success of the stock markets has been touted for years as a reason for people to park their retirement funds in the market. While we’re used to talking about the stock market’s long term returns as ranging between 11-13% (which doesn’t account for inflation), this focus misses the point: that many of the moving parts that make up the markets have seen really different returns over the long term. For example, small cap stocks typically see more volatility and over the long term are expected to perform better than larger companies that are more stable and have less steep growth trajectories. Domestic U.S. stocks perform differently over time than do foreign stocks. The point here is that in a diversified portfolio, investors gain from the fact that different asset classes perform differently, lowering volatility and improving returns over the long run.
So, while investors should diligence each opportunity as though it’s the only investment their making, the real returns come from having a long term, diversified portfolio.
The need for quality deal flow
As a stock market investor, you can just boot up your computer, log in to your brokerage, and invest in pretty-much anything you want. There’s no centralized market for investing in startups (at least not yet — companies like OurCrowd and AngelList are helping to make this happen). To become a good angel investor, you’re going to need to get access to high quality deal flow. We wrote recently on how top angel investors improve the quality of the deals they’re seeing. The more high quality investment opportunities that come across your desk, the better your chances of making the 2.5X return over 4 years, as the data show.
One clear way stock market investors can get quality deal flow is by signing up to equity crowdfunding platforms like the kind we’ve built at OurCrowd. We see over 100 deals in top startups from around the world — every month. Our diligence team stretches, pokes, and turns these opportunities inside-out until we find just a handful of investable startups that pass our investment criteria checklist. We provide access to accredited investors of all kinds (including investors with experience investing in the stock market) who want to choose their own investments from among a professionally-curated group of early stage investment opportunities.