Angel Investing (1): Dealflow – Are You Sitting at The Right Poker Table?

Posted on Sep 14, 2010 | 19 comments


Executive Summary

I believe the rise in angel investing is here to stay and the professionalization of this class (aka “super angels” or “micro VC”) is a good thing for the VC industry and for entrepreneurs.  It is basically a return to the type of VC that was done 20 years ago long before the craziness of the Internet boom that skewed things so greatly.

But with its growth and success it will encourage many people to enter the market who will lack 5 critical success criteria for earning positive returns.

This is exactly what happened in the broader VC industry between 1999-2001 as many people without the requisite skills entered the industry.  I believe that if you have 5 distinct skills you have a good chance at making great returns.  I will publish what I believe the five are in a series of articles.

But I fear that for most angel investors who invest over the long haul angel investing will not be a profitable endeavor. In fact, many really bright & connected people will privately tell you they’ve put much money to work and still don’t have many exits to show for it.  And for some reason this seems like it is seldom talked about in the press as we celebrate every check written and every name attached to them.

There is a downside.  I assure you.

The Details:

I recently finished reading “The Big Short” by Michael Lewis.  It’s a non-fiction story of many of the players at the heart of the financial crisis that became exposed in 2007/08.

It got me thinking about how in poker and in investing there are usually a few pro’s at the table and many suckers.  And as the old saying goes, “if you don’t know who the sucker at the table is – it’s probably you.”  Here’s Lewis on gambling vs. investing:

“The line between gambling and investing is artificial and thin …. maybe the best definition of ‘investing’ is ‘gambling with the odds in your favor.’ ”

This theme is reinforced in Tony Hsieh’s (the CEO of Zappos) amazing book, “Delivering Happiness” in which he describes business in a poker metaphor (paraphrasing, don’t have the book in front of me),

“the goal in poker is to find the table where you have a lot of bad players so that the odds are stacked in your favor.  It’s the same with business – choose a market in which you have better odds at winning because you’re playing against less sophisticated players.  If you’re at the wrong table, get up and walk over to a different table.”

Angel and super-seed investing are currently the “hot” area of the market right now and for good reasons.  But that doesn’t mean it’s a free-for-all for people to make money.  Mostly, this segment of the market (like all of VC) is stacked in favor of the few.  We all think it’s an even table and we have the same shots at making money as the next guy.  Unfortunately that’s a myth.

So I’m going to offer my view on the “angel poker table” so you can decide if you really want to sit there.  If you do, make sure you’re not the sucker.

Here’s what the angel investors (whether individual or professional ‘super angel’ funds) who will win at your poker table will have:

1. Access to the best deal flow – I think the most obvious thing you need to be successful is access to the right deals in the first place.  Unfortunately nearly every investor “thinks” that he/she has access to great entrepreneurs, but think about the people who are sprouting up in Silicon Valley now that are developing great track records in angel investing:

  • Keith Rabois, Reid Hoffman, Dave McClure and Peter Thiel – all part of the “PayPal Mafia.”  Many have now gone on to other successful ventures such as Slide (bought by Google for $182 million), LinkedIn (founded by Reid, invested in by Keith), Founder’s Fund (established by Peter and very early investor in Facebook) and Dave who is a consummate Silicon Valley insider and sought out by many founders.
  • Aydin Senkut, Chris Sacca, XG Ventures – all ex Googlers (XG actually stands for that).  Any big surprise that Chris is a very early investor in Twitter founded by Evan Williams who worked at Google after selling them Blogger.com?
  • Founder Collective – run by David Frankel & Eric Paley (both ex successful entrepreneurs and Harvard Business School alum and East Coast Insiders) as well as Chris Dixon (sought out by every East Coast founder & many West Coast ones) and Caterina Fake (co-founder of Flickr)

I could obviously go on.  But great companies are often founded by people who cut their teeth working at a successful venture and then taking their insights and going it alone.  Their first call is often into one of the above or the many other successful early stage investors including Marc Andreessen, Jeff Clavier or Mike Maples.

Do you have access to that kind of deal flow?  How about teaching engineering at Stanford and seeing the best & brightest before they’re even out in the wild.  That’s Ann Miura-Ko of Floodgate.  Or teaching entrepreneurship at Stanford like Steve Blank.

Can you really stack up against people who have been sitting at the table longer, calculating the odds better and learning the ropes of how to best play their hands?

Are you sure?  Is yes, have a seat.  Look at a few hands.  But make sure you have all 5 skills.  Deal flow alone is not good enough.

Part 2 in this series is here.


  • http://maverickology.com S.K. Mansour

    Mark,

    Been a long time reader of your blog and a fan TWiVC, I'm already anticipating the next part of this series but would love you to chip in for those who, for example, do have capital at hand but don't necessarily belong to the “circle of investors”…

    “Are you sure? Is yes, have a seat.”

    What if not? what if I'm not sure, but I still want to be in that seat; maybe not today but someday – where do I start?

  • Mike

    there are a few options for dealflow which include http://www.microventures.com, http://www.gobignetwork.com, and thefundingpost

  • http://twitter.com/IBAssociate Entreprenuer TechIB

    And Venture Hacks Angel List – http://www.angel.co

  • http://bothsidesofthetable.com msuster

    I think surrounding yourself with “trusted” experts who have access to deal flow is a great start but also who bring all 5 skills. If you can get together with people like this then you can draft off of their experiences.

    But dealflow is not enough. As people below point out – there are databases where you can see deals. In my experience some of these are really crappy deals. I know that the Venture Hacks Angel List is absolutely high quality and I'm sure others are also.

    But also many of the deals that get done even through high quality “lists” are not going to succeed. I'll talk more about that as the series progresses.

  • http://bothsidesofthetable.com msuster

    Yes, but there is some variable quality in some of these databases. I don't want to call out any one in specific, but caveat emptor

  • http://www.victusspiritus.com/ Mark Essel

    Appreciate the breakup of the post into a series, and the anticipation. I've never considered Angel's as “suckers at the table”, but then again I only know of the one's you mentioned here (ex-founders, entrepreneurs). I'd classify these folks as smart money.

  • http://bothsidesofthetable.com msuster

    Still, you'd be surprised how many people lose money at angel investing. As with gambling – people only talk about the wins or when they're currently winning. Only their accountant really knows what happened in the end.

  • http://www.samianrosen.com/ Samuel Ian Rosen

    IMHO the most underrated skill of any poker player is knowing when to lay down a good, but not great, hand. Didn't Andreessen initially walk away from the Foursquare deal because they thought it was getting too hot? They knew they had a good hand, but it wasn't worth the price (i.e. they didn't have “pot odds”) that other players were willing to commit.

  • http://startupi.st/ Dru Wynings

    Would you not agree that AngelList solves this problem? The one downside being that in order to compete, a novice angel will have to accept worse terms.

  • http://bothsidesofthetable.com msuster

    Yes, knowing when to not invest is a very important skill. Too many people based on emotional reasons.

  • http://bothsidesofthetable.com msuster

    Angel List is awesome at improving the awareness of great potential deals. So it makes it easier to know “what's hot” but by definition not all of these deals will succeed. That's where the other four skills come in. More tomorrow.

  • http://hdemott.wordpress.com Harry DeMott

    Ah, now this is an excellent post and I look forward to reading part 2 and beyond.

    What you don't mention here – and I think it is the most important point in the post is that for the most part – all investing is judged to be successful only upon the exit. and these early investors have a tremendous advantage.

    By building up a great network of previously successful companies and technologies – they have access to a Rolodex of engineers, biz dev people etc… that allows them to quickly get to scale.

    When it is time to exit – they have the place wired – so getting to the right guy at Google is very easy relative to someone who has never dealt with the company.

    Slide is a perfect example of a highly successful investment for the founders – when the company itself never really went anywhere in terms of real P&L (I'm speculating here – as I have no inside knowledge) . Rock star founder – a host of wired investors – 4 to 5 iterations and a sale to Google. Why would Google do such a thing? Because they wanted the team that Max Levchin built up – and the technology fit the direction the company was going in – which was no surprise, I'm sure, to Levchin and team.

    I think it is the topic for an additional post – but I don't think that many of these super angels are going to be able to add a ton of operational value to companies – not because they don't have the ability, clearly they do – but because they make so many investments that they won't have the bandwidth to really concentrate on the growth of the business. Where they really will shine is very early on in attracting key hires – and later in the process if things go sideways – and they need to sell the company to another entity. That's where they will have a tremendous advantage.

    Look forward to the next post.

  • http://hdemott.wordpress.com Harry DeMott

    It is not only knowing when not to invest – but also knowing when the company is not going to make it – and selling out before it becomes apparent to everybody. Very hard decision, and really difficult on the Founder – but if they understand it and get a win out of a tough situation – they are set up again and again in the future.

  • http://twitter.com/andresmorin Andres Morin

    Great post as always; looking forward to the rest of the series. What's your take on Angel Networks (http://angelsoft.net/a/angel-investor)? How do they fit in the picture?

  • http://columbusholdinggroup.com Mark Birch

    Mark, I like the post. Not sure what your series will focus on, but I look at a few critical aspects that lead to successful angel investing:

    1) Know the space you are investing in. I get a lot of promising bio/med deals but they are simply out of my area of expertise. Anyone serious about angel investing should have more than a cursory knowledge of the market.

    2) Gather experts that you can rely on and trust to evaluate deals. I am not egotistical enough to think I know everything and someone always bring new insights to a deal I am exploring.

    3) Have an investment strategy and stick to it. Just like in my trading business, the worst thing that you can do is switch strategies when things are looking dim. The smart investor understands the markets, the trends, and sets their course. This prevents the investor from making rash decisions.

    4) Source your own deals. How? Being where entrepreneurs are, building connections, growing a network of people that are building great technology.

    Not everyone may have the Dave McClure, Eric Paley, Jeff Clavier type of access to deal flow, but there are plenty of quality deals that they will never see for me and other “novices” to pick up.

  • http://www.howardlindzon.com howardlindzon

    i am so screwed

  • http://www.seekomega.com Mark Fidelman

    Not only do a lot of Angel deals fail, but almost as many VC backed deals fail (especially in the last 10 years). Fortunately, enough winners seem to occur to keep the investment eco-system alive and well. Not sure of the 5 skills (until you publish them), but luck and timing have a lot more to do with success than most give credit.

  • http://lmframework.com/blog/about David Semeria

    Finally, the moment has come.

    After reading *all* your pasts blog posts and thinking, “Yep, dude's nailed it”, finally – finally!! – I get to break your balls.

    Have you read Animal Farm? The outsiders become the new insiders and end up behaving like the old insiders did. It was true for the commies, but it's also true for every situation were the old guard gets usurped.

    All those investors you mentioned. Smart as a button, to the last. Good people. And they will all make good money; but they are all — to different extents — the new establishment.

    I don't hear too much talk of Mike Moritz these days – another good person (purely on the basis that he personally replied to a cold email from me).

    Being an insider has its advantages and disadvantages. It's no use having a the best contacts in Memphis when four kids from Liverpool go viral.

    Who knows where the next home run will come from? The web has become cheaper, but it's also become more geo-distributed. What if some Russian hackers get bored emailing “Hi, my name is Katerina and I liked your profile picture” ? ChatRoulette came from nowhere (I'm not suggesting he was an ex-spammer, btw). How does an SV super-angel, super-preemptive, super-duper network get those deals first?

    The next one could come from anywhere!

    Nah…. nana… nan-a-nan-ahhh

  • http://lmframework.com/blog/about David Semeria

    Um, that was a bit fruity. I should remember not to turn-on the laptop after the pub.
    Didn't spot any typos, though – a sign of quality :)