The past 2-3 years have been a golden period for the Indian startup ecosystem. The exponential growth has slowed a little only in the past few months, as it has globally. Steady growth and positive macro-economic factors since 2008 created a huge opportunity that a few smart entrepreneurs spotted early. Their success has created an environment where entrepreneurs are no more outcasts, but are instead the rockstars.
In parallel, the local angel investing ecosystem has boomed as well. As a result, many investors who aren’t close to the startup ecosystem are beginning to invest in startups. Sometimes, they do it without understanding the associated risks.
The euphoria has slowed in the past 3-4 months, and a few funded startups have run aground. While there is a lot of media coverage and harakiri talk going around, one should remember that most of the startups fail. Let me re-phrase: Most of the funded startups also fail.
And hence, this seems like a good time to revisit the thumb rules of angel investing:
- Allocation: At most 10-15% of the total investment portfolio across all asset classes should be invested in startups.
- Portfolio: Due to the high failure rate, risk should be spread over a portfolio of 5-10 startup investments at the minimum.
- Expectations: In a portfolio of 10 startups, 4-5 will definitely go bust, 3-4 might be able to return the invested amount, and 1-2 might become blockbusters. ‘Might’ is the keyword here.
- Financial planning: Investment should be made with zero expectation of return. No future financial planning should rest on the expected return from angel investments.
- Illiquidity: Even for the success stories, the minimum expected holding period for angel investors is 3-5 years. In case of an emergency, startup investments don’t help.
Angel investors whose investment philosophy isn’t in line with the above are treading much thinner ice than they should.
How thin is the ice under your feet?