Putting More 'Pearls' In Your Angel Portfolio

By: Marianne Hudson, ACA Executive Director

This post originally appeared on Forbes.com

Every angel portfolio needs some real gems to provide an overall return.  Selecting which companies to add to your angel portfolio sometimes feels like hunting for an elusive pearl among thousands of oysters. So many look the same from the outside. Are there telltale signs that point to which oyster contains the pearl without having to pry open every one?

Developing a strong angel portfolio includes a couple of pieces.  It’s important to build a diversified set of deals in your portfolio and to figure out how many companies to invest in and which types to focus on. Another piece to the puzzle is to follow good investing practices to make each individual investment decision.  In other words, there are tried and true ways to increase the chances that you are actually selecting good investment deals. The simple truth about finding pearls—investment or otherwise, is this: both require a crystal ball, however there are definitely proven ways to increase your odds of success.

Here is some practical advice from three veteran angels, John O. Huston, founder and chair emeritus at Ohio TechAngel Funds,David S. Rose, founder of the New York Angels and Dan Rosen, chairman of the Alliance of Angels in Seattle. I have tried, use and recommend these simple processes. With a little luck they may help you put more pearls in your portfolio:

Select entrepreneurs you trust. If you can’t work with the people in the company you want to invest in, it can’t work. Huston says, it’s like “the old Warren Buffet comment—you can make a bad deal with a good person, but you can never make a good deal with a bad person.” Make sure they are being honest with you. Integrity goes a long way.

Do your due diligence. Every company will carry some amount of risk. There is no way to know at the beginning how things will turn out during the life of working with a company. So you must know the ins and outs of a company before investing. This requires doing due diligence. The downside is it will slow down the amount of companies you have time to invest in or the time required will make you miss a competitive deal when other investors make quicker decisions, but that may not be a bad thing. If something in the company is off and you don’t do the deal, it’s better for your portfolio. Due diligence is easier if you stick with what you know. Focus on your region or area of expertise. Be honest with yourself about how many deals you can analyze and do a good job on.

Make sure the math works. Sometimes a company seems so promising, you don’t realize that the math actually doesn’t work to your favor. Make sure that as an angel, your investment and your exit make sense even if it seems like the startup has unusually big potential. Don’t invest in companies with overly high valuations, for instance. Huston’s experience has taught him a lot along the way in this regard. “When I first started investing 15 years ago, I was all about trying to see if this company could turn into a great company. Now having seen such companies turn into great companies but absolutely lousy investments for me, I am much more focused on whether this is a good investment for the angels.”

Consider more than an initial investment. The one-and-done idea may not work to your advantage as an angel; if the company needs more money later, doesn’t get it and then goes under, then you have a loss and your portfolio suffers. Address this by monitoring the company’s finances and being prepared to offer an initial investment plus an additional investment later. This offers great visibility into the company and helps you make better decisions about whether to make additional investments in the business.

Draw from the knowledge of other angels. Talking with angels provides opportunities to meet with likeminded angels to discuss potential deals: you can find out strategies for finding start-ups, assessing their value, how much to invest, and when to exit.  Think about taking a class from the Angel Resource Institute or attending an Angel Capital Association event, or ask a local angel to have coffee – you’ll be surprised at how much information and learning they will happily share with you.

In the end, selecting great companies for your angel portfolio requires a little bit of investment time and good processes. To increase your success, learn all you can about the best practices experienced angels use. One of my favorite approaches is to network at angel events and to listen to the experiences of veteran angels to see which approaches fit your style. The ACA webinar “How to build a great angel portfolio” is a good place to start.