Be an angel investor

Original Author: Christopher Allen

Original Link: On Being an Angel

Last month, a venture capital blog linked to my blog (Life With Alacrity) and categorized me as a venture capitalist. I'm not actually a venture capitalist; I'm an angel investor.

This week, the topic of "reforming VC" or "remaking VC" has been very popular. This discussion was initiated by Dave Winer, with Robert Scoble, Doc Searls, Jeff Nolan, Michael Arrington, Thatedeguy, and other industry insiders sharing their views.

What's my take? All forms of startup investment—seed, angel, venture capital, and funds—are high-risk, high-reward ventures to varying degrees. To talk about reforming venture capital and related investments like angel investing, we first need to understand how they operate.

What is a Venture Capitalist?

A venture capitalist is a partner or associate at a venture capital firm (VC Firm), making them an employee of the firm. They manage money for larger fund investment companies that have even more substantial resources.

Statistically, large fund investment companies (like pension funds and insurance companies) can allocate a small portion of their funds (approximately 1% to 5%) to high-risk, long-term investments. If these investments fail, they can be offset by more stable investments; however, if they succeed, they provide significant returns, thereby increasing the fund’s internal rate of return (IRR). Statistically, this allocation strategy is foolproof. Therefore, these fund investment companies typically invest in several high-risk categories, including entrusting money to VC Firms.

A VC Firm manages multiple funds from these investment companies and invests them into small, pre-IPO startups. The VC Firm charges a management fee of 2%-3% of the total funds under management. This fee is collected regardless of whether the investments succeed or fail and is used to pay the salaries of the employees at the VC Firm. If the investments are successful, the VC Firm also takes 20% of the profits (known as Carry), which is shared among the partners, with rare instances where associates may receive a small share.

In reality, it's the associates who do most of the work within the VC Firm. They earn high salaries, but what they truly hope for is to discover promising startups, manage the investments well, and generate high returns. In doing so, when the VC Firm raises another round of funds from the investment companies, outstanding associates have the chance to become partners, enjoying truly massive returns and potentially starting their own VC Firms.

However, the chances for associates to rise to the top are slim. Generally speaking, managing investments in seven startups simultaneously is already pushing the limits of an individual's capacity. Another widely accepted statistic in the venture capital world is that only one out of five startups will break even and survive; only one out of twenty startups will "scale up," compensating for the losses of other failed investments. Some new VC Firms claim they can achieve one out of ten, but I tend to trust the more traditional conservative estimates. Due to these statistics, associates aim to manage more than seven companies' investments and must fiercely compete with other associates for good investment opportunities. This way, they increase the likelihood of having one of the one-in-twenty successful startups in their portfolio, giving them a one-in-five to one-in-three chance of becoming partners. Such competitive pressure often prevents associates from dedicating sufficient time and effort to each investment project. It's not that they don't want to give their all to every investment—they simply face such low success rates that they might not even manage to secure a successful company within their portfolio. [...]