10 Common Angel Investor Mistakes in Down Markets

By Dror Futter, Legal and Business Adviser to Startups, Venture Capital Firms and Technology Companies

For more than a decade, we’ve been in an U2R (up and to the right) venture market. As a result, many angel investors are confronting their first prolonged down market. Here are 10 common mistakes for angel investors to avoid as they consider new investments and follow-on investments.

  1. Throwing Good Money After Bad
    Your prior investment is a sunk cost. When a venture approaches you for follow-on investing, don’t think of it as “protecting” your investment – it rarely is. Also, don’t view this as dollar cost averaging – that may make sense in the public market but does not work in venture. Make the new investment decision on its own merits based on valuation, deal terms and the company’s prospects.
  2. Catching a Falling Knife
    Even though the company’s valuation has fallen by 50% since your initial investment, its new shares are not “on sale.” We have just concluded a period of excessive valuations. The process of rationalization of valuations, and the resulting write-downs, likely will continue for a while.
  3. Good News is Just Over the Horizon Syndrome
    Every venture has that one company-saving deal that has been “stuck in legal for months” and should close any day now. If it has not closed until now “they may not be that in to you” and is probably not the best data point on which to base your investment.
  4. Doubling Down Rather Than Diversifying
    Most Angel Investors are under-diversified. Academic studies have recommended 20 to as many as 50 ventures as the optimum diversification in this asset class. Rather than adding money to sustain struggling existing investments, consider using funds to diversify and have “more horses in the race.”
  5. Underestimating Zero
    Unless you are really unlucky, most public company shareholders will never see investments go to zero. Not so in venture. The majority will not return the initial investment and a large number will return “zero.” This is an unappreciated risk by many venture investors.
  6. Overvaluing Pro-Rata/Under-Valuing MFN
    Remember how important pro-rata rights were in 2021? In 2022, not so much. Many ventures will be all too happy to take your funds. On the other hand, if you are investing through SAFEs or convertible notes, make sure they have MFM (most favored nations) clauses. These clauses will give you the benefit of more favorable terms given to subsequent investors. 
  7. Remaining FOMO Driven
    For the last few years, there has been a frenzied pace to investing. Lots of checkbooks out there and “U Snooze U Looz”. We are moving to a buyer’s market – so take a deep breath, ask the tough questions, perform due diligence and seek better deal terms.
  8. “So and So” Invested is Not Due Diligence
    Let’s be honest. Over the last few years, due diligence has kind of fallen out of favor. Especially in the early stage, investors would draw comfort from the fact that fund X or super angel invested. Turns out, in a lot of cases, they were not diligencing much either and in the current market you really need to do your homework.
  9. Forget TAM and Think Unit Economics
    Remember those breathless slides identifying a trillion dollar total addressable market and if the venture captures just 1% it will be the next Google? Those times are over. Now it is important to focus on unit economics and whether there is a realistic prospect of the venture turning profitable – on a cash basis, not just through an accounting metric.
  10. I Have Rights
    As a SAFE or convertible note holder, you have surprisingly little protection. You are likely not owed fiduciary obligations of shareholders and even if your note is treated like debt, the protections afforded creditors mainly kick in once a company is insolvent or approaching it. If your SAFE/Note have converted, the Age of Parri Passu is likely over. Your investment is likely to be buried underneath a senior liquidation preference.

About the author: Dror is a venture capital and technology attorney who advises startups and their angel and venture fund investors and helps more established tech companies negotiate complex agreements.