This is the second article in a series on what it takes to be a great angel investor (and why this should matter to entrepreneurs). Part 1 – Access to Great Deal Flow – is here.
I have talked extensively about “social proof” in fund raising in the past. But the problem is that most deals – even really promising ones – fail. Just ask the people who poured money into once “hot” companies like RazorGator or Friendster. And we all know that Ron Conway is considered the savviest of angel investors and yet by definition not all of his investments succeed.
So being buddies with “all the right people” clearly isn’t enough to be successful. AngelList – as great and innovative as it is – does not guarantee success for investors. Obviously. In fact, sometimes seeing social proof (e.g. lots of brand names piling on) can lead to group think and price creep. I personally try to avoid many of these club deals. I like to invest where I have a personally strong connection with the entrepreneur and/or a strong intuition on the market from prior experience. I like to be early – usually first or near enough to it.
Basically, I’m talking about being an angel leader and not follower. Lead investors and follow investors can both win equally but in each case you know why you personally are writing the check. I have been at cocktail parties where I have heard prolific angels upon hearing that a buddy was backing a deal say, “count me in for 25″ even without knowing the details of the deal. I think that’s sloppy.
It requires domain knowledge to know what you’re talking about and success long term as an angel. We are all thrown some good cards from time-to-time. That’s called luck. Consistently winning like Keith Rabois takes skill.
2. Domain knowledge – Unfortunately many individuals overrate their own abilities in the “domain knowledge” area. They have very a very good sense for what is going on a market but not a well-honed knowledge of an industry and what will define success or failure.
I see this all of the time in financial services. So many deals seem like obvious money makers. But then I talk with my partner Brian McLoughlin who has worked in the field for 20 years and he’ll run through the 10 reasons why similar companies haven’t succeeded. Not in a cynical way – he just has the domain knowledge to know what has been tried before. It’s sort of like having an Encyclopedic history book before just launching your product and seeing whether anybody uses it.
Just because you use all of the products, read all the tech journals, back-channel at all of the right cocktail parties and know a couple of guys at Twitter or Facebook does not mean that you necessarily have well refined domain knowledge.
Remember that you’ll be investing against people who have worked on the Google algorithm and REALLY know what drives SEO. MySpace may not have been as successful as Facebook in the end but the executives there learned how to deal with user growth at scale. They have real stories about what drives user engagement and viral adoption.
Here’s the thing – as Michael Lewis talks about in his book, the adage of investing is that “if you’re reading about something in the papers it’s already too late.”
Think you know a thing or two about location-based services? You’re going up against Dennis Crowley who built Dodgeball before ever founding FourSquare. Oh, and he was acquired by and worked at Google. Connections. Domain knowledge.
Who ultimately invested in FourSquare? Fred Wilson who had learned much as an early investor in Twitter. And before that Bryce Roberts who working alongside Tim O’Reilly (famed publisher and originator of Web 2.0 Expo) gets advanced access to and domain knowledge of the who’s who of the tech world.
Want to do a Q&A website? The founders of Quora were respected technologists at Facebook and knew a thing or two about bacn and toast before setting up their highly sought after venture. And when they wanted money they turned to none other than Matt Cohler, ex VP of Product Management at Facebook. Access to Deal Flow. Domain Knowledge.
I know you have good knowledge of how the Internet is developing and have good intuition of what drives viral adoption, what local services are needed, what API’s need to be developed, etc. But before you get out your check book at least have a gut check on whether your instincts are likely as refined as the other players sitting at the table. It’s not good enough to win at the weekend warrior table – you need to win at the WSOP table.
The most interesting thing I’ve learned by being an investor and sitting on boards & seeing so many company pitches is how different reality of what is going on at companies is from what you’re reading about them in the press. So it’s not good enough to only mine Techmeme every day.
In the Tony Hsieh analogy – it’s the difference between a weekend player and a professional. In the former you place a couple of casual bets knowing you may lose. Some early wins can be deceiving and give you a sense of invulnerability. The same happens in poker before you lose big. Professionals play day-in, day-out for years at a time. They spot the tells. They count the cards. They control outcomes.
Yet the truth is that I see angels with great deal flow & great instincts whom I believe will only perform well in times that favor angel investors (like 2010) where there are early exits. I don’t believe these times will last. And the best investors over the long-haul will need three more skills.
Part three will be published shortly.
(Cross-posted @ Both Sides of the Table)