Should you become an angel investor?

Becoming an “angel investor” and putting your money into start-ups sounds very attractive, as stories of multimillion-dollar payouts abound. Angel investments come with high risks, though, since the vast majority of start-ups fail. Before you put your money in, it is important to understand more about investing in start-ups and whether you can handle the risks.

HOW ANGEL INVESTING WORKS

An angel investor is an individual who invests in a start-up in return for partial ownership of the venture, in the hope that the start-up succeeds and the investment earns a good return. Some investors have made thousands or millions of dollars, for example, by investing in start-ups ranging from Google or Facebook in the United States to Viki or Luxola in Singapore.

Finding start-ups to invest in has become increasingly easier in Singapore. Along with tapping into family and friends who know people starting up companies, investors can connect with the accelerators that have sprung up in recent years to nurture start-ups or with organisations linking angel investors to start-ups. From long-time stalwarts such as Business Angel Network of Southeast Asia to newer ones such as Angel Investment Network, the number of angel networking organisations continues to grow.

Once you’ve found a start-up that seems attractive, you will need to dig into the details to find out whether the company is as promising as it sounds. Most entrepreneurs have an exciting story, a passion for their product, and many reasons why their company will become the next big thing. Finding out whether the story is real, whether target customers will buy the product, how the start-up will make money and if the company can protect its product from copycats are just a few of the many critical facets to consider.

If the investment seems promising enough, the angel investor will need to figure out how much to put in and what share of the company he or she will own. Although entrepreneurs in countries such as France and the US have created platforms that pool investments so that investors can invest US$1,000 or less in start-ups, such platforms are only in their nascent stages in Singapore. While start-ups in the very earliest stages may still accept just a few thousand dollars, start-ups that are a little further along often want investors to put in at least S$25,000 to S$50,000.

How much of the company you will own in return for that investment depends on factors including how long the company has existed, its current valuation, who the other investors are and the stage at which you are investing.

MANAGING THE RISKS

Along with deciding whether the start-up is promising enough, you will need to decide whether you can accept the risks and afford the investment.

The risk of investing in a start-up is indeed substantial. As NUS Professor Francis Yeoh wrote in TODAY, a 70 per cent failure rate is typical of venture capital investments. Other researchers put the failure rate for start-ups as high as 90 per cent. Since there is a high chance that the start-up will fail, angel investors should consider whether they have the financial and emotional wherewithal to absorb the loss and cope with failure. If you invest S$25,000 apiece in three to five start-ups and they all fail, for example, would you still be financially stable and cheerful?

Even if you are comfortable with the risk, you need to consider how long it will take to receive any payout. Successful start-ups can easily take between two and ten years to reach a reasonable size. Even then, you are only likely to see a return if the company is sold or lists on exchange. If you can handle these risks, experts still recommend investing no more than 20 per cent or less of your portfolio.

Rather than investing in just one start-up, it is also better to invest in several in order to diversify your risk. Many experts recommend investing in at least ten start-ups so that you have a greater likelihood that at least one or two will succeed.

THE GROWTH OF ANGEL INVESTING IN SINGAPORE

If you can accept these risks, there is clearly no shortage of opportunities. Mr Edwin Chow, Group Director (Industry & Enterprise Development) at SPRING Singapore, told TODAY earlier this year that the number of high-technology or knowledge-intensive start-ups increased by more than 90 per cent from about 2,800 in 2004 to 5,400 in 2014, and the number of active young companies more than doubled from 23,000 to 55,000. That number may well expand rapidly: A report by web-hosting company GoDaddy showed about 75 per cent of millennials surveyed in Singapore plan to become entrepreneurs within the next ten years.

The rewards can be lucrative, too, as at least 27 Singapore-based start-ups were acquired in deals totalling more than US$500 million between 2013 and 2015.

Becoming an angel investor can be exciting and lead to big payouts. At the same time, there is substantial risk. If you do your homework and can afford to lose the money you intend to invest, it could be worth considering becoming an angel investor.