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In last five years, eight companies from India have crossed billion-dollar valuation mark. This number is expected to grow significantly in next five years. A lakh worth of shares of OLA five years ago would have been worth more than INR 30 crores now.

I am sure you would have often wondered about the crazy valuations of these companies and the thought naturally comes, is it really possible to make money by investing in some of them? Have you also thought of becoming an angel investor and don’t know where to start?

Initially, angel investing was restricted only to rich investors as the access to good companies and diligence costs were prohibitive. But, with the emergence of technology platforms, individual investors can invest as low as INR two – five lakhs in one company and create an angel portfolio in INR 20 – 30 lakhs. Moreover, these platforms aggregate lot of information about companies, which helps investors in taking informed decision.

Three core reasons why one should look at angel investing

  •      Highest return as an asset class (40% Average Annualised return)
  •      Can contribute in the success of a small company
  •      Can learn new things and be part of journey of an entrepreneur

Before turning an angel investor, an individual should understand how to evaluate an angel investment opportunity. You should evaluate the team, product or service that the company is into, it’s addressable market size and traction. It goes without saying that team is the most important factor in the success of a company. You need to assess the commitment of team and their ability to execute. If they are building a technology product and one of the co-founders is not a technology guy, it is difficult to build a great product.

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The second aspect is the product/service itself. It is not first because for early stage companies, the product/service evolves but team generally remains intact throughout. The third aspect is the size of the market for the product/service one is trying to sell. If the overall market is not large enough, they will have difficulties in getting next round of capital. The fourth aspect is traction. Traction includes number of users who are using the product/service (paid/free), their experiences and revenue generated. If large number of users are willing to pay for the product/service, the company has a good chance of success.

There are two types of companies that one generally comes across. One, highly scalable and other, soon to be profitable companies. I am not saying both are exclusive but in general, highly scalable companies are not profitable for quite some time. A scalable company needs lot of capital and has the potential to give very high return but the downside is that if it doesn’t get next rounds of capital, the entire money can go down the drain.

As opposed to this, there are companies, which have clear visibility of becoming profitable in a short span of time. These companies may not give phenomenal returns but the downside is also limited as they can survive without external capital beyond a point. As an angel investor, you should plan to invest in both kinds of companies so that you have good upside as well as limited downside from your portfolio.

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But how do you decide the value of a company that you wish to invest in? Valuation is more of an art than science. It’s very difficult to determine exact value of a company. Hence, people generally talk about a valuation range. E.g. a typical early stage company with very little revenues is generally valued between INR 5-15 crore, depending on team, growth potential of the company and initial traction (if any). For revenue making companies, there are valuation benchmarks that take growth, margin and revenue multiple into account while valuing a company.

Many a times, investors feel that they got a great deal as they got the company at a much discounted rate due to some non-compliance issues. However, they need to realise that the company might continue to be non-compliant and might face issues, which can lead to shutdown of the company. So, it’s generally better to buy a company at a higher valuation with good track record as a good company continues to get higher valuation (and capital!) as others will also pay a premium to buy it.

Moreover, like in equity investing, the portfolio approach to investing also plays an important role for angel investors. You should work towards building a portfolio of small companies – some early and some growth stage. Research shows that if you invest in more than seven companies, your chances of getting good returns on your portfolio are fairly high.

Further, every new company that you invest in makes you a better angel investor. So, you should plan to build the portfolio over a period of time. Also, it is better not to invest more than 10% of total investible surplus into angel investing as it is highly risky. Besides, being a highly illiquid asset class, it is better to stay invested for long term (at least three years).

Last but not the least; don’t depend on others for your money. You should do your homework before investing so that you not only earn but also learn in the process.

Note: The views and opinions expressed are solely those of the author and does not necessarily reflect the views held by Inc42, its creators or employees. Inc42 is not responsible for the accuracy of any of the information supplied by guest bloggers.