Where angels dare to tread

Passed on the chance to invest in an unknown start-up, which later turned out to be Justdial?

The search services provider, which went public last year, helped its initial investor Raj Koneru, who had invested around ₹6.5 crore in 2000, earn an estimated return of 25 times in 2007, when venture capital firms Sequoia and Tiger Global bought out his stake.

Investing in the very early stages of a company, known as angel investing, can offer rich rewards, but plenty of hard work and a good bit of luck are needed to pull it off.

Why invest Investing in blue-chip stocks in the secondary markets may offer only modest gains.

The Sensex has managed an annual return of just 13 per cent in the last 10 years. But it is in the very early stage of a venture that one can unearth rare business ideas that can turn out to be multi-baggers.

For instance, the investment by Mumbai Angels in Inmobi, a mobile advertising network, multiplied 25 times.

In the stock market, an individual investor has to jostle for space with the big guys, such as foreign institutions, mutual funds and insurers. But if you’re an angel investor, you get to pick and choose your investments.

Today, while there are over 10,000 start-up ideas thirsty for capital, there are just 500 to 800 ‘angels’ in India to fund them, says Chennai Angels Network, a group of angel investors.

If you’re an entrepreneur yourself, nurturing a business by using your surplus funds can be a big payoff in itself. Padmaja Ruparel, President of Indian Angels Network (IAN), notes that many successful entrepreneurs wish to engage in a profitable way with young, innovative start-ups.

Managing risks That said, triple-digit returns seldom come without risks, and so it is with angel investing too.

For one, the rate of failure among untried start-ups can be high, with only 10 per cent of the companies allowing their angel investors to forge a successful exit. Two, funding a business and sitting on its board can come with risks you never anticipated.

For instance, an angel investor said that as a board member, he was dragged to court for non-disclosure of certain information when the start-up received later stage funding.

Homing in Having decided to play fairy godmother to start-ups, you may be tempted to write out that big cheque as soon as you are approached by someone with a bright business idea.

Before you even begin discussions with potential investees, make sure you have a large list to choose from.

Access to a larger pool of entrepreneurs increases your chances of choosing a winner instead of a ‘me-too’. This is where it pays to join up a larger network of similar-minded investors. For instance, Sam Mehta, who is part of Chennai Angels, says he used to get only three ideas a month on his own.

Now the number has zoomed to 40 a month, routed by Chennai Angels. But not everyone with pots of money can be a successful ‘angel’, as separating the hits from the flops may need an intuitive feel for business, apart from a little grey hair.

“Over a period of time, one gets a gut feel as to what is a good idea and what is not,” says R. Narayanan, an angel investor.

If you’ve worked or done business in a particular area, try and select your investment from that sector. If you’re venturing into unfamiliar territory, don’t hesitate to tap into the expertise of others in your network.

Devil is in the detail Ideas may be a dime a dozen, so what is the due diligence needed to filter the promising ones? Resist the urge to go entirely by the story or the pitch made to you by a passionate founder.

Drill down to hard metrics such as market size, potential growth rates and business plan. IAN members note that they look for a unique and distinct idea that has the potential to scale up.

Druva, a provider of data protection solutions to enterprises, has been successful not just locally but has also globally.

And, yes, plans may remain castles in the air without good execution capability. Therefore, the credentials of the founding team need to be verified.

One red flag that angel investors should look out for is the inconsistency in the founder’s story during interaction.

This usually indicates that the founder may not have full conviction in the idea or has not thought through the investment plan well.

Some angel networks even do background checks on the entrepreneurs to rule out issues. “I check if the founders have their skin in the game and are committed to the cause,” says Vivek Pai, a member of Bangalore Angels Network. Today, several start-up ideas are incubated by large tech firms, such as Microsoft or venture funds. Such enterprises may have a head-start over rivals in scaling up their businesses.

Even if you find a once-in-a-lifetime opportunity, be prudent in valuing the firm, using listed benchmarks or inputs from merchant bankers or legal firms to arrive at the price.

Follow up

If all this looks like a lot of work, there is more. Angel funding is not a ‘invest and forget’ sort of investment. It requires a lot of ongoing commitment of your time. Most angel investors are entrepreneurs, senior executives in large firms or belong to business families.

The start-ups too look up to angel investors for mentoring. The angel investor’s knowledge and experience helps start-ups in charting strategies and building contacts, says Baskar Ethirajan, founder of IndiaStage.in .

Even without direct experience in the sector, the angel investor may act as a sounding board for ideas, adds Rakesh Malhotra, Chairman, SAR Group.

“The value-add is the Rolodex — network of connections that open up to start-ups,” says Padma Chandrasekaran, an angel investor. Yes, many angels may not be able to spend the four to six hours every week to actively mentor the investee. But a quarterly review and being there for the promoters when critical events unfold are essential.

When returns don’t fly

After all the capital and time invested, not all angel investments click (that’s why it’s called ‘angel’ investing — it has got a selfless element to it). Returns may typically take four years or longer, by which time you would know if the idea is working. But in quite a few cases, you will have to brace yourself for failure too.

Market makes a difference Usually, angel investors make their returns via buyouts or when a venture capital firm is willing to dive in. But investment appetite is often a function of market conditions. Even a brilliant idea may fail to get funding in a moribund market while a so-so idea may be lapped up in a bull market.

Domain expertise So, how do you keep your risks minimal? Through diversification, say successful angels. “You cannot hit the bull’s eye the first time, so it is better to manage a portfolio of five to six investments,” says Sateesh Andra, Managing Partner of Ventureast Tenet Fund. However, some angels caution against mindless diversification and feel it is best to stick to sectors you understand. Ramesh B. Byrapaneni, a cardiologist, limits his investments to the healthcare sector. “Invest large amounts in a few companies that you understand rather than spread it out in companies you don’t,” he says.