About two years ago, before the pandemic broke out, I spoke to Alexandre Scialom, a business angel friend of mine based in Silicon Valley who is working on building up his own fund, Fresh Ventures. Alex told me that any Business Angel hoping to invest in Y Combinator startups must sign a million-dollar checks to get a seat at the board. That’s a lot of money, especially if you’re broke. So I asked Gustavo how one could become a business angel when one is broke.
Gustavo pointed that investing in Y Combinator startups comes with advantages and disadvantages. On the plus side, Y Combinator founders leverage an extensive network in the most promising entrepreneurial hotspot in the world and are actively sought out by venture capitalists. So any Y Combinator business angel must be reassured: VCs will offer to buy the shares at a premium as the company grows.
However, many business angels are seeking to invest capital in a Y Combinator founder. Therefore, one must get ready for a stiff competition: capital is lavish and talent is scarce.
Alternatively, Gustavo pointing out that one can find many business angel organizations by:
- Regions like the New York business angels and the Paris business angels,
- alumni like ESSEC Alumni BA
- topics like Women-only Business Angel groups.
And I know from experience that the minimal investment ticket there can be €5000 which is more reasonable than the 1 million dollars needed to get a seat at Y Combinator. And, yet €5000 is not nothing. Gustavo concurred.
And that’s when he mentioned another way to go: joining AngelList. Gustavo told me about the story of the websites founding. Its co-founder, an Indian-American serial entrepreneur and investor in over 200 startups, Naval Ravikant, wanted to invest in Uber in very early days. But he lacked the capital to get a seat at the table. So he sent an email to a list of business angel friends and wondered whether any of them might want to invest in Uber with him. He was struck by the number of business angels who were also seeking to invest in startups and lacked the capital to make a meaningful contribution. And that’s when he decided to build a website dedicated to the matter.
Now, how does it work? Business Angels join the website, source startups, choose one and invest $1000. At that point, other business Angels join the angel lead and form a syndicate collecting up to $200,000 investment. The business angel lead will then represent the syndicate at the startup’s board, not only based on his own $1000 investment but also for the remaining $199,000.
Now, what happens when? How does compensation work? In the venture capital world, typically. Get paid based on two different revenue sources:
- First, they retain a 2% management fee based on the size of the fund.
- Second, they get a performance-based pay based on value creation, also known as “carried interest.” It ranges anywhere from 15 to 30%, 20% being the more common rate.
So it turns out that Angels on Angel list don’t enjoy non-performance-based management fee. But they do get to tap into a 20% carried interest. So let’s assume that you’re the business angel lead and you achieved a 10X return. Where? The $1000 that he invested in the startup returned $10,000 and the $200,000 Returned 2 million. In that case, the value created is 2,000,000 minus 200,000, which is 1.8 million. So the business Angel lead would get 20% of 1.8 million, which is $360,000. Not bad!
Overtime, Business Angels build meaningful relationships with high potential founders to get invited to sit on the board. After five years of 5 to 10 years of business angel investing, some business angels go on and create a venture capital fund of their own. So that’s a story of how to become a business angel when you’re broke. More below!