Sometimes writing  a blog post can be a learning experience in its own. If you have something you are wondering about, writing a post can be a way to clarify and publish your research. It leads to a lot of new discoveries and helps sort out ideas.

Lately I’ve been thinking about what it would be like to do some moderate angel investing on the side. Is it possible to create a portfolio that will generate real returns?  So, I set out to research some of the best philosophies and crunch some numbers to see if the finances could possibly add up.

The first thing I always do when I am wondering something like this is post the question on Quora. I asked, “What is the best way to angel invest a million dollars?” As usual, I had my question answered in around 24 hours. The best thing I like about Quora is the answers are usually credible, because they do such a good job curating the community.

In the answer, I got some great tips. Information like; the number of total investments you would need to spread risk, the amount of money you need to “follow-on” your top investments, and how long it should take you to invest the whole fund.

I’ve compiled a possible approach to angel investing with a million dollars. I try to combine some of the investing techniques, and break them down into phases to explain better.

1.  Getting Started – Taking the initial leap would have to  be very difficult.  Knowing you would make some $25,000 or bigger investments that would net a big zero would be a scary thought. This would be especially hard after working tirelessly to make your own money to invest like some angels.

2. Initial Investment – Once you have made the leap, the next step is to start writing checks. Literally. You need to make enough small, early stage investments in companies to create a “portfolio”. Statistics on angel investment portfolios show:

The median expected return for an angel investor increases by more than 50% when a portfolio grows from 5-10 investments and by more than 100% when a portfolio grows from 5-20 investments.

With $1M to invest you need to make enough investment to create opportunities, but save some money to “follow-on” to the top companies in the next investment rounds.  I think in this situation, one could make around 30 investments over three years, at 10 per year. The average investment for these initial investments is $18,000 totaling $540,000.  I would put $15,000 in most companies and save a few $20,000 investments for what you think are the top companies you are working with.

The initial investments would be the most difficult part of the investing process. Creating the deal flow to make 10 solid investments each year would be no easy task. You have to then support and service the companies you are working with as well. Again, no easy task, particularly if you are not doing this full time.

3. Follow-on Investments – At this point the fund would then have $325,000 for follow-on investments. This would average out to about 7 more investments at around $50,000 each.

At this point you should know your companies well, and I would probably take more liberty with this money than making standard $50,000 investments. I would range these investments from $25,000 up to $100,000 depending on how the company has performed since your initial investment. Things like market development and technology trends should also be considered in the follow-on stages.

4. Management Fees – So you have made the investments. What are the other parts of running an angel investment fund? One thing is management fees.  Even if you are investing your own money, you are going to have to have some operating income. Typically, most venture capital firms charge a 2%-2.5% annual management fee on committed capital. Surprisingly the finances that I crunched allowed for a 2.5% management fee on the million dollar fund. That came out to $25,000 a year over 5 years, or $125,000 total. In addition to this there was $10,000 left over for any other miscellaneous operating expenses.

5. Conclusion – Just to clarify everything I have added a brief financial breakdown below to better explain how the process would work.

  • $1,000,000 Start
  • $540,000 – 30 Investments Averaging $18,000
  • $325,000 – 7 Follow-on Investments Averaging $50,000
  • $125,000 – Management Fees at $25,000 Year x 5 years
  • $10,000 – Miscellaneous Operating Expenses

What else have I missed? What are some details I have not considered? Share some comments on the likes/dislikes of this idea below.