Angel Investing Requires Education

Angel investing is a very “sexy” strategy right now. Everyone wants to invest in the next hot startup; have that big exit; and make tons of money. Celebrities are doing it. Your friends are doing it. Former Bankers are even doing it.  Now with the JOBS Act, accredited investors* can invest in tech startups using online platforms like AngelList. Angel investing is when an individual makes an investment during the early stages of a startup’s development. Only a small percentage of those startups eventually become successful. There is very limited access, and a lot of money floating around. This means that in turn, a lot of people are going to lose. Why? It comes down a simple lack of education.

The JOBS Act is a great milestone for the future of online investing. As accredited investors, people can invest in deals that were never available to them before. There’s more access, the fees are cheaper, and the minimum investment size is smaller. In the case of angel investing, it’s democratizing an investment strategy that is otherwise very exclusive and expensive. However, you can’t just become a successful angel investor overnight.

Non-accredited investors have pushed back on the JOBS Act for what they believe is an unfair definition of an accredited investor. Under the Act, a person who makes $200,000 per year or has a net worth of $1 million or more qualifies as an accredited investor. Let me explain further: the recommended allocation of an angel portfolio is 1-5 percent of your investable capital because your chances of losing are very high. Those with more flexible lifestyles, such as single individuals with no children and no debt generally allocate a riskier 5-15 percent. The minimum investment size per deal on AngelList is $1,000. To be diversified, we need at least 30-50 companies in our portfolio. On the low end, we need to have at least $30,000 to invest across 30 companies over the course of a few years. Let’s say that we do 10 deals per year, over 3 years, with $10,000 per year ($1,000 times 10). If we’re making $200,000 per year, that’s 5 percent of our annual income (and this is not even investable income).

If we use the same example for a non-accredited investor making $100,000 per year, they would only be able to get to a portfolio of 15 companies with the same 5 percent allocation. That’s simply not enough to be diversified, which means they would have to increase their allocation and take on more risk. There is no problem with allowing individuals to do that, as long as they’re educated in what they’re doing. Education is the key to private wealth management, whether you have a $1,000 or $1 million.

Recently, Congress passed Regulation A+ as an addition to the JOBS Act. This allows non-accredited investors to invest in tech companies, but at its later, pre-IPO stages. That’s a whole other beast. A lot of people probably don’t know that these are more mature companies and also don’t know how to differentiate between late-stage and early-stage investing as part of their overall portfolio. For those hoping to capitalize on the additions the JOBS Act brings, it’s all about getting the right education.

Mesh Lakhani is a family office investment allocator and Founder of the Future Investor Courses, recently launching one on angel investing. He speaks frequently about the future of asset allocation using online platforms.