By Susanne Chishti
CEO & Founder, FINTECH Circle; Chairwoman, FINTECH Circle Innovate
The “angel round” is normally the first external funding round to inject cash into a FinTech start-up by accredited, high-net worth (HNW) investors. Most great tech success stories were backed by fantastic angel investors who really believed in the team and their vision and helped to make it work. Thus each FinTech firm needs great FinTech angels backing them up all the way. This chapter helps finance and technology leaders to find out how they can personally benefit by becoming FinTech angel investors.
So how can you personally benefit from the enormous growth of the FinTech sector? The two main options are to either become an entrepreneur trying to build the next FinTech success story or to become a FinTech angel investor. As an angel investor you invest your personal funds to help the best FinTech entrepreneurs build their business in order to sell it or go public many years later to make a good return. The most valuable companies of tomorrow’s finance sector are being formed today and if you only invest via the stock market into publicly listed stocks and funds, these opportunities will not be available to you. Private investors can be part of the journey from the beginning by providing much needed capital to the best start-ups and small and medium-sized enterprises (SMEs).
David S. Rose, founder of New York Angels, summarized it so well by providing the following example: “This form of investment can be extraordinarily lucrative. When Ben Silberman approached New York Angels in April 2009, seeking a small investment in his interactive mobile catalog idea, he valued his company at $2.5 million. Today, just over four years later [2013], Pinterest is valued at $3.8 billion – an increase of 152,000 percent.”1 So angel investors who backed the initial funding round have done extremely well. In 2015 Pinterest Inc. raised $367 million, giving the online site a valuation of $11 billion and making it one of the most highly valued start-ups by venture capitalists in the world.2
So how can you get involved, how can you become an angel investor? Two key principles should apply – first only invest in what you know and secondly, only invest the money you can afford to lose. Similarly to crowdfunding, there is no guarantee that you will get your investment back. HNW investors often use an asset allocation strategy when building their investment portfolios which might consist of a core portfolio of passive investments (for example exchange traded funds) in combination with a range of satellite investments such as property, hedge funds, private equity, and commodities. The key thing is to never put all your eggs in one basket – a lesson we have all heard before.
So where does angel investment fit in? What differentiates successful angel investors from the rest is their passion for a certain industry because of their previous experience and skills. Often this passion and deep domain expertise drives and empowers them to pick the winners. Post investment smart angels like to play an active role in the success of the company by doing anything in their power to help the company grow. That is why all FinTech entrepreneurs need their angels!
FinTech angels often come from the financial services and/or technology sectors combining deep domain expertise in retail, corporate, investment banking, asset management, private wealth management, or transaction banking with technology understanding and the curiosity to explore new technologies such as blockchain innovation, for example.
So where do angel investors make the best returns? Very few statistics exist and many are outdated. However one recent survey of business angels was published in the UK, featuring responses from 403 angels, and drawing data from angel syndicates and networks comprising 8,000 individual investors, entitled “A Nation of Angels” which shared the details of their best- and worst-performing investments.3 Financial technology came out on top with FinTech as the most lucrative sector for angel investment, delivering the highest growth compared to any other industry.
The report also found that these early-stage investors are getting younger in the UK, more female, and are increasingly likely to back companies outside their local area. In 2008, the median age of a UK angel investor was 53. In 2015, 44% of UK angel investors are under 45 years, and almost three-quarters are under 54. The proportion of female angels stands at 14%, up from just 7% in 2008. The rise of women-only angel networks has helped the gender gap to narrow slightly, but the UK still lags behind the US where 20% of angels are female. Thus the FinTech sector needs more angel investors and more female angels to join to ensure that the best companies get funded.
So how do you become an angel investor? What are the key areas you should be aware of when starting to invest?
Diversification is king.
Among private investors and VCs it is often expected that at least half of their investments will fail, thus out of 10 investments, you would assume that at least five will fail, three to four might return the original investment, and one will be the big winner, where the exit will be so extraordinary that it compensates for all losses. Thus you rely on 10% of your portfolio generating enough return, so that the overall portfolio return is attractive.
The problem for investors is that nobody knows who the winners will be and therefore investing in early stage companies is a numbers game. David Rose summarized it in this way: “Several studies and mathematical simulations have shown that it takes investing the same amount of money consistently in at least 20 to 25 companies before your returns begin to approach the typical return of over 20% [per year] for professional, active angel investors.”1
Understand the investment lifecycle/finance ladder of a start-up.
Angel investment normally comes after the friends and family round and before VC funding and is normally focused on amounts between £100,000 and £1 million.
However, these lines are blurring as we have seen with FINTECH Circle, Europe’s first angel network exclusively focused on FinTech opportunities, where we co-invested with early stage VCs during 2015. You also need to be aware that every successful company will need more money to grow and your stake will be diluted unless you are able to join the follow-on rounds.
Dealflow is key to identifying high-potential opportunities.
The better your dealflow, the more likely it is that you will pick a winner. Therefore the best strategy is to align with like-minded investors and become well known in the marketplace so that the best FinTech companies approach you before approaching others. Most frequently angel investors join syndicates where angels combine their knowledge and expertise in evaluating companies and then co-invest together. Without great dealflow, you could be the best stock picker but it would not help because the opportunities you see are limited.
Top angels will provide “smart money”.
When companies start to grow they not only need money, but mentors/advisors (whose interests are aligned with the founders) to help them grow their business. This help could mean introducing them to your contacts and network of potential partners and customers. It could mean helping them to validate important business assumptions, providing resources (to which they would not otherwise have access) or helping them with their value proposition and business model to achieve product/market fit. Being an angel is such an opportunity to be both an investor and mentor/supporter of the start-ups you have backed. You are on their side and they know it.
Angel investing is personal.
As an investor you need to back the founding team wholeheartedly, which normally means you must like them, trust them, and believe in them to execute their plans. You will want to spend time and energy with the FinTech firms you back to understand their backgrounds and if they have what it takes to succeed. Angel investing takes time to build the rapport on both sides as it is equally important for the entrepreneurs to feel comfortable with their investors. A well-known FinTech entrepreneur once told me that he does not take on investors whom he does not enjoy going to lunch with. That makes perfect sense – being invested as a private investor is like a marriage which neither you nor the entrepreneur can leave easily.
Evaluate their pitch, presentation and technology.
Key documents investors often look at are executive summaries (that’s an important document because if that does not sell the opportunity, the investor will not look further), investor decks, business plans, or financial forecasts. Thus it is key to spend time preparing the investor deck well and also to make it visually appealing. First impressions count on paper, online, and in person. In order to assess the proposed tech solution, angels will leverage their own expertise and network of relevant industry contacts.
Now let us assume you have found a great FinTech company at an Angel Network Event, met the founders in person, really liked them and their product, discussed their pitch with other FinTech angels who also want to back it in the form of a very complementary angel syndicate (in terms of combined expertise and available networks across financial services and technology), and now you want to take it further. This next phase is called “due diligence”, where it is key to explore the details of the management team, the products/services and traction to date, the market size and opportunities for global expansion, route to market strategies, competitive advantage, and exit options. Due diligence can be done together or one angel can take the lead.
The difficult next step is agreeing on a valuation. Normally FinTech firms will have an idea about their valuation and about how much money they are looking for. This will normally be part of the pitch deck made available to angel investors. However valuations are never set in stone and can be negotiated taking into account:
This is obviously not a complete list as books have been written on the topic of valuation, which is a difficult combination of science and art especially for start-ups.
The negotiating process is again an opportunity to go into more details on company leadership, and discuss important questions in terms of control and decision-making, including the protection for minority shareholders, all summarized in the important “shareholders’ agreement”. In addition there will be other documents to sign depending on which country you are based in, a process which can be very complex and tiring for the FinTech entrepreneurs who are always relieved when the fundraising process is over as it is a distraction to their business.
After the investment the key objective of smart angels is to add value to their FinTech firms. Assuming that you are an angel investor with great domain expertise in some of the verticals across financial services such as retail, corporate or investment banking, asset management, private wealth management, transaction banking/payments, or crypto-currencies/blockchain technologies, your contacts and previous experience will be extremely valuable to the founders and you should try to help them wherever you can.
Finally, a very important benefit of angel investing is non-monetary – being an active angel is fun. It can be very rewarding to meet inspiring entrepreneurs, mentor and coach them, actively participate in their journey, feel the excitement when things go well, and try to find solutions when challenges occur. Creating your FinTech portfolio of angel investments will be an amazing experience. It is entrepreneurship without the responsibility and helps you keep up with the latest disruptive technologies and trends and it is satisfying to be able to give back. Thus there is definitely a social side to angel investing. For those investors who want to invest in FinTech start-ups but have no time to be active angels or might not be permitted to pick their own investments (as there might be a conflict of interest with their day jobs), specialized funds exist which focus on investments into FinTech companies.
FINTECH Circle angels attend great start-up and educational events, are invited to mentor the best FinTech entrepreneurs, and are intellectually challenged and stimulated which helps to see the future of finance and personally benefit from the FinTech revolution. You and your angel network can fund the best FinTech start-ups, laying the foundations for their future success!
4 David S. Rose, Angel Investing – The Gust Guide to Making Money & Having Fun Investing in Startups (John Wiley & Sons, 2014).