Angel Investing: The Challenges Ahead

We live in "interesting times" for sure, like in the alleged curse attributed to the Chinese. Nobody knows which gods we managed to piss off, but fresh out of a once-in-a-century pandemic, we stumbled into a European war. Supply chains look all messed up and energy prices keep rising, which create enormous problems and uncertainty for every economic actor.

The global inflation and the Federal Reserve rate hikes implemented to deal with it impact everybody, even the florist in the corner on your street. Amidst all this, angel investing is facing a unique set of challenges. How angel investors tackle these problems will not only define angel investing for years to come but have a bearing on the startup ecosystem, too.

Changing demographics

A new breed of angel investors is filling up the ranks nowadays. These newcomers are entrepreneurs who previously led startups to successful exits and decided to try a new role in the ecosystem. These tech entrepreneurs are aged 40 to 45—twenty years younger than the dominant group of investors up to this point. They are more technically aware, which is a blessing for the startups they will invest in and the founders they will mentor.

However, they are also used to a more hands-on approach, having taken their startups from zero to one with a small team and hard work. The transition from a successful career as a founder to an angel investor role takes a mental shift. It is like a world rally champion retiring from the sport and then trying his luck as a co-driver to an up-and-coming driver. The fact that you are no longer running the show but providing help might be challenging to accept for some. Luckily, as Y Combinator partners illustrate, founder-turned-angel investors are smart enough to recognize what their new roles demand and adapt accordingly.

How to combine technology with intuition

In their book, Play Bigger, Christopher Lochhead and his friends estimate that the cost of developing and launching a software product fell by 100 percent or more between 1990 and 2015. The emergence of cloud computing played a big part in this reduction. This new technology leveled the playing field for every company, enabling startups to enjoy similar cost structures to enterprises without the scale. Andrew Jassy led AWS's pioneering efforts in taking this particular technology to the masses. He has been quoted many times summarizing his vision when he started AWS:

"Any individual in his or her own garage or dorm room could have access to the same cost structure and scalability and infrastructure as the largest companies in the world."

Cloud computing achieved this vision, allowing people to develop software products from scratch and be competitive right out of the gate. The result was a never-seen-before proliferation of startups, making sourcing and screening investment opportunities much more difficult for anybody willing to invest.

Harnessing the power of artificial intelligence (AI) and machine learning (ML) can solve the problem of vetting all these investment opportunities. ML-based algorithms may have failed to attract much attention from elite angel investors due to their inability to help with evaluating the intangibles of a founder and his team. But the enhanced computing power they bring to the table can take care of much of the heavy lifting in gauging the potential of startups.

Sam Altman believes the days of investor leverage against founders are over. It's a founders' world now, and angel investors need all the help they can get to identify successful startups as soon as these companies start their journey. In the future, success in angel investing will be defined by execution speed. Taking too long to pull the trigger on a deal pushes founders away and damages an investor's reputation, translating into less business in the future. Only investors quickly spotting and getting in contact with founders and closing deals without wasting time will get the first dibs on the best startups.

There is a place for ML in this race against time. ML can be trained to crawl the web pages and social media accounts of startups, tracking metrics like team size or social media activity. Once ML filters the list of startups and narrows it down to a handful of companies with meaningful improvement in the selected metrics, it's time for angel investors to shine. With the tedious part of the job out of the way, they can now apply judgment and gut feeling to pick the best ones.

It works just as well with recruitment, too. Beril, our talented and super-entrepreneurial Senior Product Designer, knows a thing or two about this, as she previously co-founded a platform bringing together angel investors and startups. Beril likens ML's potential role in angel investing to an "HR module for angel investors." For example, do you need a CTO who led a biotech startup in the past before he ran out of money? ML has you covered. Define the parameters, and ML will prepare a shortlist of suitable candidates that fit the bill for you.

The need to look for new horizons

As the investment scene in the U.S. and Europe matures, the competition among angel investors to spot promising startups intensifies. All that screening and due diligence go to waste when an angel investor fails to close a deal in the face of competition from other angel investors. We previously touched upon how local bias influences angel investors intimidated by the lack of information regarding startups in distant locations and cause them to invest in local startups. However, the tight investment market and the ever-rising startup valuations make it necessary for angel investors to strongly consider other markets with hidden gems.

India

India currently ranks third among the largest startup ecosystems, right behind the U.S. and China, and enjoys a predicted year-on-year growth rate of 12-15 percent. The total number of registered startups in the country stands at 61,400. As of September 2022, the country is home to 107 unicorns with a total valuation of $340.79 billion, 44 of them joining the list in 2021.

The Indian startup ecosystem looks enticing, with immense potential for growth, particularly in the e-commerce, fintech, and SaaS segments. The increasing penetration of internet technologies helps unlock this potential. Indian startups achieved a compound annual growth rate of 49 percent from 2014 to 2021, more than four times what Chinese startups managed. These figures remind angel investors that getting priced out of the U.S. market for early-stage startups can be a blessing in disguise if they have prospects lined up in India.

Africa

The African startup market accounts for only 0.2 percent of the $3.8-trillion global startup market. African startups raised just $1.1 billion in 2020. Numbers look modest, to say the least. However, it is the growth trajectory that is intriguing: The amount of funding raised in Africa in 2020 was more than twice the number in 2019, and it more than quadrupled in a year, reaching $4.9 billion in 2021. The continent is experiencing a boom in population, and mobile phone and internet penetration are on the rise. The stage is set for exciting developments in the startup market.

The most successful African startups are in the fintech segment, taking financial services to the unbanked masses. As of 2021, there were four African unicorns, three of which were fintech companies. The average startup size still remains small, though. While the median seed round is worth $2,882,000 in the U.S., it is worth around $140,000 in Cape Town, South Africa, arguably the most startup-friendly city on the continent. Angel investors finding it hard to compete in the U.S. would face better odds in Cape Town, Lagos, or Johannesburg. However, there is still much to be done on the bureaucratic side of things. African governments should improve the existing legislation and introduce regulatory frameworks to create an environment favorable to startup growth and build trust with investors.

Venturing into a different continent is a daring act for anyone, local bias or not. To mitigate the risks, angel investors willing to explore new markets would be well-advised to get in touch with local business angel networks. Networks provide foreign angel investors with local partners who know the lay of the land. They help foreign investors overcome the information asymmetry, source good startups worthy of investment, and vet them, increasing their odds of success. Angel investors need reliable and fast procedures to do business in uncharted territory, and these networks, with their accumulated know-how, can fill the need.

Conclusion

The challenges awaiting angel investing are no joke. But they also present opportunities for people who can conquer them.

A new generation of angel investors will inject new blood into the system and bring fresh insights with them. Harnessing AI and ML will help angel investors cast a wider net and make better investment decisions. The investment scene in the U.S. is more competitive than ever, but the developing startup ecosystems in India and Africa offer angel investors opportunities at more affordable valuations than Silicon Valley. Once overcome, these three challenges can catapult angel investing to another level.