With startups staying private longer, and late-stage valuations trending ever higher, Angel investors are increasingly thinking about early liquidity options. For Angels in “brand name” startups, emerging secondary markets for private company shares are sometimes an option. Lower-profile, late stage startups sometime offer early Angle investors liquidity options via sales to larger, later stage investors. In both scenarios, Angels face a basic question: should they take a modest gain now, or hold on for a possible homerun?
It seems to me the “rule” in this situation (there will always be exceptions) is really pretty straightforward. If an Angel is an occasional investor, take the early exit money and run. On the other hand, if the Angel is a regular investor with a broad portfolio of investments, hold on or consider doubling down.
Here’s the logic. Venture investing, and all the more so in earlier stages, is a portfolio game. It’s a game where you hope to get three or four times your aggregate invested capital back, with those returns driven by a couple of homeruns for every ten or so at bats. That model implies two rules for serious Angel investors. First, you need to do a lot of deals, because picking deals that actually return 10 times is really hard; and second, every deal has to have 10x+ potential, because it’s the few deals that deliver 10x+ returns that drive the performance of the portfolio. (For a simplified early stage VC portfolio investment model that you can play with to illustrate this, drop me an email.)
So, for a serious, portfolio-driven Angel investor, an early opportunity to cash out at say a two to four times return doesn’t usually make sense because it involves capping a deal’s return at a fraction of the 10x+ returns that you must get from somewhere to make the portfolio payoff. Not only that, but it means cashing in at two to four times (or whatever) on a deal that has matured to a point – it has successfully attracted later stage investors – where it presumably is now a better bet to get to 10x+ return than it was when you made the Angel investment.
On the other hand, if you’re only an occasional Angel investor, a bird in hand is probably worth more than two in the bush. A modest return on a one-off deal – perhaps a return that would satisfy the portfolio return expectations of an early stage VC – is for me a keeper if you only make an occasional Angel investment. And if you do cash in your chip for say three times the return or more, you’ll be getting a payoff that most early stage venture investments never deliver.
So, again, the rule: If you are a regular Angel investor with a good portfolio of deals, don’t bite on an early exit opportunity for a modest upside; hold on (and maybe even double down if you can) for the possible home run. On the other hand, if you are only an occasional Angel investor, if the opportunity to cash in for even a modest gain presents itself, take the money and run.