Angel Investing is known for its high return potential, its role in funding the future of innovation, and for the opportunity to create impact, but it doesn’t come without its risks. Together we’ll touch on a few of the risks angel investors face and how to mitigate them throughout your investing journey.
If this article leaves you ready and excited to jump into the world of angel investing, join us at Angel Fest May 8 & 9 in Minneapolis, MN. The conference will provide opportunities to learn invaluable lessons from experts, hear compelling founders stories, engage in breakout sessions, and dive into the due diligence process. Come curious; leave inspired!
Setting Yourself up for Success Despite the Risks
A risk often linked to angel investing is the high failure rate of startups. According to an article by Hubspot, 90% of startups will fail and 10% of startups will fail before their first year in operation. Locally these odds look more promising, as the Minnesota Chamber of Commerce cites that Minnesota companies have a nation-leading 56% success rate past their 5th year. However, failure is still an inherent aspect of early-stage investing. While high odds of failure demonstrate why it’s important to only invest what you can afford to lose, there are strategies that can improve your chances of success as an investor.
To reduce the risk of failure as an early-stage investor, it's important to conduct thorough due diligence. Due diligence involves qualitative and quantitative research, looking at factors ranging from management team, market size, competitive landscape, business model, and traction. Conducting due diligence is an important way to identify potential red flags early on.
There are also other methods you can take as an angel investor to try and increase your odds of successful returns. An Angel Capital Education Foundation study found that higher returns were often correlated with time spent on due diligence, industry expertise, and frequency of portfolio company interactions through mentoring or coaching.
Iliquidity
Another risk associated with angel investing is lack of liquidity. According to an article by Medium, a startup takes 7.5 years on average to exit. This means as an angel investor, any capital you invest in startups can be tied up for years (if not lost completely due to startup failure, as noted above).
First, it’s important to prepare for illiquidity by having a long-term mindset. This will help prepare you for any natural delays or failures seen at an early-stage, allowing you to focus on value creation for portfolio companies (which takes time), and reduce any emotional decision-making based on short-term changes.
To manage illiquidity challenges you should work with your financial advisor to ensure you are balancing your angel investment with other more liquid investments, in your overall investment portfolio.
And certainly do not use money you will need in the short-term to make angel investments. A great approach is to identify how much you are comfortable investing into early-stage investment over several years, then spread it across a portfolio of companies. Doing so will help you avoid investing too much too fast, while also staggering potential exits.
How to Preserve Your Investment
As an early-stage investor, dilution is an important risk to recognize and prepare for. Angel investors typically participate in one of the startups first capital raises. According to Antler, a startup will likely go through four or five funding rounds before they exit. As a company progresses through the raising process to an exit, they will continue to raise more capital at a (hopefully) higher valuation. A study by Carta shows that each of these subsequent raises may lead to 15%-30% dilution for existing shareholders.
It is important to remember dilution itself is not bad. Think of this as slices of pie. When you first invest you have a piece of a tiny pie. As the company grows, the pie grows with it, so while your ratio of that pie will get smaller you can still come out with more pie overall. Nevertheless, there are a few investment rights you can negotiate for to help protect your investment. Check out this article by Angel Basecamp, discussing commonly used angel terminology, for more details on commonly used investment vehicles, such as convertible notes and SAFEs, as well as commonly negotiated terms like valuation caps and discounts.
A well-diversified portfolio is key to managing risk in early-stage investing. Spreading investments across multiple startups increases the chances of success and helps mitigate potential losses from individual failures.
It would be ill-advised to invest your entire retirement account into one company’s stock, even if that company is Apple or Google. The same is true for your angel investments. So if you wanted to invest $100,000 you would statistically be better off putting that into 10 companies instead of one.
How to Properly Diversify your Portfolio
A well-diversified portfolio is key to managing risk in early-stage investing. Spreading investments across multiple startups increases the chances of success and helps mitigate potential losses from individual failures.
It would be ill-advised to invest your entire retirement account into one company’s stock, even if that company is Apple or Google. The same is true for your angel investments. So if you wanted to invest $100,000 you would statistically be better off putting that into 10 companies instead of one.
In his blog, Learnings from 100+ Angel Investments, entrepreneur and investor Daren Cotter shares that setting an overall target on the amount you plan to invest then dividing that amount by the total number of investments you plan to make will help determine the amount of capital you’ll want to contribute for each company you invest in.
Regardless of the number of portfolio companies you invest in or the check sizes you write, always be thinking about building a portfolio. So when I say angel, you say portfolio!
As with all investments, there are risks involved with early-stage investing. While this list is not an exhaustive list of risks, they are the most common ones that get brought up. Make a personal plan to mitigate these risks and set yourself up for success.
If you’re excited to learn more about the realm of angel investing, join us at Angel Fest 2025 on May 8 and 9 in Minneapolis. The conference is filled with engaging sessions, networking opportunities, and the chance to apply your insights through startup pitches and group discussions. We hope to see you there! Get your tickets for Angel Fest here.
