Study Indicates Follow-on Funding Gives Lower Returns for Angel Investors

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In 2007, Professor Rob Wiltbank reported in Returns to Angel Investors in Groups that angel investors made follow-on investment in about 30% of their invested companies. It was surprising for me to learn that follow-on investments correlated with lower returns, that is, angels that made follow-on angel investments saw returns of 1.4X their investment, while those that did not make follow-on investments enjoyed 3.6X returns.  The time to exit for both groups was similar.

How does a “one and done” investment strategy by angels provide higher returns?  I think there are several contributing factors, such as:

  • There are a few angel funded deals that take off so quickly that the startup entrepreneur can easily raise $5 million or more in venture capital in the next round.  These deals are likely to provide early investors with very high returns.
  • On the other hand, too many of us angels” throw good money after bad,” that is, we don’t pull the plug early enough.  We become convinced that our funded startup is just about to turn the corner…when they really aren’t.  So, we fund the company a second or perhaps even a third time before we acknowledge that the company simply cannot be successful.  These follow-on investments have a significant negative impact on portfolio returns for angels.  And, candidly, this is an important area of improvements for angel investors.
  • Some angels invest in only one early round of funding, strategizing that the early rounds provide the highest returns.  Investing in later rounds only reduces the total return from any single portfolio company.
  • Furthermore, some angels choose to invest in more companies rather than multiple rounds in the same company.  With a fixed amount of capital reserved for the angel asset class, these investors look for improved returns through a diversified portfolio.
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