🔑 Why Angel investing is a good way to lose money
Welcome to The Business Academy with Sieva Kozinsky. Here's what we have in store for you today:
- Angel investing is a good way to lose money
- How PE firms turn $5m into $25m instantly
- Let's buy an accounting business?
Angel investing is overrated.
A couple months ago, I wrote about my most successful angel investment ever.
Here's what happened:
5 years ago, I invested $25k into a startup.
This year, I received $1.1 million from the investment (a 113% annualized return).
You should avoid angel investing at all costs.
Angel investing is misunderstood.
It's not about analyzing business models or projecting cash flows like you might think.
Angel investing is all about access.
If you're not in the inner circle of elite founders and Silicon Valley insiders, you won't even get the chance to look at the best deals.
The reality is that only about the top 5% of startup investors make a lot of money.
These are professionals who spend every waking hour on the craft.
It’s unlikely that you are investing part-time and also in the top 5%.
If you don’t live in cities like:
- San Francisco
- Los Angeles
- New York
You are not getting top-tier deals. Period.
It’s usually just some random charismatic guy coming to you for money.
Most angel investors are investing in average companies.
You cannot invest in average companies and be a successful investor. Why?
Here is the math behind startup investing (for the best investors in the world):
- 65% of startups fail, returning nothing to investors
- 25% return 1x or 2x your money
- 10% drive 3x returns or greater
- 1% drive 10x returns or greater
If you make 20 angel investments, at least 2 of them must be grand slams, returning 10x or more on your investment. These are not average. These are world-class companies, with world-class outcomes.
If you can't invest in these, you will never make money as an angel investor.
Consider another example I found that resonated with my experience:
Angel Investing Is Difficult To Succeed For The Average Investor
Let me share with you an angel investing example I had in a gin company back in 2010 and the outcome.
After 10 years, my $60,000 investment in a private gin company finally paid dividends.
Initially, given the company was sold for about $49M after expenses and I had invested in the company at a $10M post money valuation, I was thinking I had made a ~3X return ($180,000). Since over time shareholders get diluted with subsequent funding rounds, I thought that was a reasonable assumption.
Well it turns out I didn't come close. Instead, here's what I got:
Gross Proceeds: $98,425.88
Federal Withholdings: $0
State Withholdings: $6,523.82
Net Proceeds: $91,902.07
What the hell!? After almost 10 years, with $98,425.88 in gross proceeds, I only made a 64% return on my money (1.64X). Further, I had ZERO liquidity and lost hope for years that I'd ever get my $60,000 back.
Doing the math, I only made a 5.1% IRR, barely better than my guaranteed 4.1% 7-year CD that just expired.
There are many lessons in this story, including never invest in an alcohol start-up, but the outcome described here is the most likely one you will experience.
Angel investing gets glamorized in the news because it's sensational. It looks like a lottery ticket. I'm sure you've read an article that sounds like this:
An investor turned $50k into $25 million by being one of the first investors in Google.
But those huge wins are few and far between. When we actually look at it objectively, angel investing has many unfavorable characteristics:
- No liquidity, no cash flow
- High variation of returns (everything is either a 10x+ or a zero)
- Long time horizon
- Investor has no control over the outcome
- Long payback period
- Usually no dividends/distributions paid out
If you're looking to build wealth as an investor, step 1 is "don't lose money".
I'd much rather concentrate my capital and time on an opportunity that predictably and consistently compounds over time; like buying and operating a boring, profitable business.
🔑 How Private Equity Firms Grow Companies
How does a PE firm turn $5 million into $25 million instantly?
The short answer is that larger companies sell for higher multiples than small companies.
Say a PE firm buys a $5m EBITDA business for 5x EBITDA, but their platform can be sold for 10x. That means PE firms creates $25 million of value for themselves simply by adding companies to their portfolio.
But there's a lot more to it - including how they grow the companies they acquire.
This post explains the "magic" of private equity, and why PE loves using debt to buy companies.
🔑 One interesting deal
I've been fascinated with the Bench story this past week. In case you missed it, Bench accounting suddenly shut down a few days ago with no notice to thousands of customers - just a few days before year end. But Jesse Tinsley just announced that he purchased the company (I'll be having him on my podcast soon).
With that deal going on, I figured we'd look at an accounting business for sale:
What I like
This tax prep and accounting business has 15 employees, including an owner who'd like to stay on. I'd consider this a positive. The owner wanting to stay on signals that they like the business and expect it to keep doing well. Maybe they're just tired of running the business and would rather have a job.
I also like that the business has been around for more than a decade. I'd much rather buy a company that's been around long enough to endure some ups and downs.
What I don't like
The first thing that jumps out is the asking price - it sounds too high to me. According to the listing, the owner works full-time in the business and is very involved. That usually makes a business command a lower multiple. However, the price isn't outrageous and could be reasonable if a portion of the sales price involves some sort of seller financing.
If this business relies solely on the owner to function, then we will need to run the other way (unles you're a CPA yourself)
Have a great week,
Sieva
P.S. I've been publishing more shorts on YouTube with some of the most interesting moments from my interviews. subscribe on YouTube if you haven't already to check it out.
Disclaimer: nothing here is investment advice. Please do your own research. The information above is just for information and learning.
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