Angel: How to Invest in Technology Startups—Timeless Advice from an Angel Investor Who Turned $100,000 into $100,000,000

by Jason Calacanis

if a startup in which you are an early enough investor becomes a unicorn—a company valued at $1 billion—you will return life-changing money.

However, there is one rub: your shares can be “diluted” over time as the company sells more shares to other investors. The impact of dilution can be mitigated against if you take your “pro rata” in future rounds.

Pro rata means you continue to invest additional money in each subsequent round to maintain your original percentage ownership in a company. It’s generally a good idea, but it can get very, very expensive if you hit a major unicorn.

In order to be an effective angel investor, you need some combination of money, time, network, and expertise. You don’t have to have all of them, mind you.

The best angels in the world have four qualities, giving them the ability to (1) write a check (money), (2) jam out with the founders over important issues (time), (3) provide meaningful customer and investor introductions (network), and (4) give actionable advice that saves the founders time and money—or keeps them from making mistakes (expertise).

When someone tells me they have a founder they want to introduce me to but they’re worried because the person is a wild card, I set that meeting up for the next day. Angel investors are looking for wild cards, because the best founders are typically inflexible and unmanageable, pursuing their visions at the expense of other people’s feelings.

Your goal as an angel investor is to put yourself in a position to hit one of these decacorns (unicorns worth over $10 billion) or decade-acorns (the startups that come along once a decade, on average, and become worth over $100 billion).

We live in a world full of network effects. The nodes in the network here in the Bay Area are the investors (angels, incubators, and venture capitalists), founders, service providers (colleges, lawyers, headhunters, and banks), and the talent pool (developers, designers, and marketers). The number of folks rooting for and directly helping the startups you invest in will be a thousand times more in the Bay Area than anywhere else. The greatest product Silicon Valley ever built was Silicon Valley—which, generation after generation, reinvests in and propels itself to ever greater levels of efficiency.

The next group of startups, the ones you’ll invest in, will study how these four companies ran the table on dozens of countries, and thousands of cities, and do it that much faster.

Right now you’re probably thinking, “But don’t all startups begin with the founders owning 100 percent of the shares?” True. But not all founders are willing to begin working on a startup without an outside investor. Many of them hold out for that first check like it’s a security blanket. I prefer founders who are willing to pursue their visions long before an investor comes along and takes some of the pressure off of them.

What this signals, in my experience, is that if these founders someday run out of money—and almost all startups do—they will likely revert back to not paying themselves, while still pushing the company forward with their effort, in order to save the business (and your investment). These are my people, the hustlers and the builders. As the world figures out you’re an angel, you will be crushed with a legion of founders who want your backing, and most of them will not be the “sweat equity” type.

On one hand, they have the audacity to take money from their families, which if they lose will make for an awkward Thanksgiving, but on the other hand they could be entitled, self-absorbed dreamers who don’t mind burning their friends’ and family’s money.

Investors can get very excited when a category or a founder breaks out, and when they do, they lower their standards because they believe the wind will be at the startup’s back.

These days, I look at each bridge round I’m asked to participate in with a simple question: What has changed since I made my original investment?

Oftentimes, the answer to “What’s changed?” is that the founder and their team have learned a ton about their customers, they’ve built a promising product, and they’ve learned what they need to do in order to hit breakeven. In those cases, it’s fairly easy to justify a continued investment. There is one serious caveat to all of this: the valuation and terms of the bridge.

If the seed round was at a $4 million valuation and the company has learned a ton and landed some customers, but the valuation has stayed the same, you should put more money in than you already have.

Pro rata means you get to keep your percentage ownership in a company. Typically when you angel invest, you don’t get pro rata rights—unless you demand them, and then you do. I won’t do a deal without pro rata rights anymore. If someone doesn’t think I deserve to get to keep my percentage ownership, even though I was one of their earliest supporters, well, I’m not the right investor for them—and they’re not the right founder for me.

Options are a great way to align employee motivations because now they are part owners in the business, too. Options typically vest over four years. So, if an employee leaves the company after only two years, they only get to keep half of the options that were granted and the rest go back into the pool for future employees.

When faced with decisions, such as “Should we sell the company for fifty million dollars?” or “Should we raise ten million dollars for twenty percent of the company?,” you can have a candid discussion—informed by the cap table.

For the two founders, with fifteen million shares each, they will often be tempted to sell their company early. In this scenario, they would be faced with a $15 million payday each, which is hard to turn down when you probably have massive credit card and student loan debt, a modest startup salary, and zero savings.

They also might consider selling half their shares to investors in a new round ($500,000 worth) as “idiot insurance” in case the company eventually fails, while letting the other half ride.

If the company fails, they will feel like a genius because, well, they made five times their investment while other shareholders lost everything.

The point being, there are only two numbers that matter: how much you put in and how much you got out. How much your shares were worth at their peak is not remotely as important as when you choose to sell them.

The velocity at which startups can rise in technology is second only to how quickly they can implode.

These days I only take a board seat in my portfolio companies if—and this is a major condition—they are surging or under some sort of unfriendly attack that requires me to join the board to protect them and other shareholders. Outside of my own investments, the only way I would join a board of a startup is if the founders were friends or I were massively passionate about the company. Why? Life is short and the return of being on a board these days would be de minimis compared to my returns as an investor.

Opportunity cost is an extremely important concept in life, so let’s talk about it here for a moment. My definition of opportunity cost is “the lost gains resulting from the misapplication of your time.”

It’s simple to calculate. Just ask yourself what else could you have done with those two hundred hours and what impact it would have had on your startup.

How to allocate your finite time and energy efficiently is something you constantly have to revisit as an investor, founder, parent, and human being. The cost of not revisiting your allocation of time is great, leading to massive regret at having spent too much time on a startup, marriage, friendship, or investment that is destined to disappoint you or destroy your soul.

The point of this story is to remind you that advisor shares are not guaranteed, and in the private company game, there are very few rules and very many ways to screw over your partners. You only have to look at Mark Zuckerberg’s early lawsuits—and settlements—to see how ugly and often these things go down. You’re going to need to have a great lawyer, have clearly defined deals, and be selective about the people you partner with. Even when you do all of those things, you’re still gonna have people try to screw you. It’s the nature of money, power, and, most of all, shares in companies.

Venture capitalists typically charge what’s called “20 and 2” to their LPs: 20 percent carry and a 2 percent management fee. The management fee is money advanced by the LPs to the partners in the venture fund in order to pay for their overhead (salaries, office space, tickets to expensive conferences like TED and Davos). Those management fees get paid back out of the returns, but they are a point of contention with LPs in the venture capital industry. On a $300 million fund, a 2 percent management fee is $6 million per year. For a seven-year fund, that’s $42 million in management fees! Many LPs think these fees are extreme and want them reduced.

For all ten of the startups you select, you need to write a “deal memo” explaining why you’re investing, what you think the risks are, and what you think has to go right for the startup to return money on your investment. You will review these deal memos every time the startup raises a new round of funding so that you can test if your original thesis still applies. What you’ll undoubtedly learn is that no one knows exactly how or why a startup breaks out, but there are trends—especially in how you think.

For every startup you didn’t invest in, write clear notes on the reasons why you passed. You will look back on these notes and learn exactly how bad you were at this, and over time see how much better you’ve gotten.

I’ve stopped trying to understand what will work and what won’t, and instead I use my Jedi powers to understand how strong the Force is in the founder.

The best deals never see the light of day. They’re quickly filled by insiders who are sharing deal flow, and by elite founders with killer startups tapping their existing network.

If you are bothered by people sending you random email introductions, you are in the wrong business!

Again, never say yes in a meeting. Let them know that you need to do research and think about the deal terms.

If you’re doing it right, your days as an angel investor will be packed with pitch meetings. Like anything in life, though, no matter how unique and special those days are, they can become repetitive—and you can develop bad habits, unprofessional tendencies, indifference, and even outright contempt.

You should allocate three hours for each startup meeting: one hour of prep, one hour with the founders, and one hour of postmortem.

Over time I’ve learned that your best next question is hidden in the subject’s answer to your last question. I’ve interviewed thousands of people as a journalist, podcaster, and investor, and in that time the best interviews are the ones that morph into conversations. In a conversation you don’t have a list of questions to run through, you have a discussion partner who you volley ideas back and forth with.

What I learned is that, while no one knows which of the great founders and startups will have breakout success, it’s fairly easy to know which founders and ideas are so shitty—or worse, small—that they have no chance of breaking out. I use two methods to sort through the deluge of startups contacting me. I eliminate the small ideas and weak founders. Then I double down on the great founders and big ideas.

If folks are building a startup for money, they will eventually quit when they realize there are many better ways to make money faster and with more certainty.

The big problem with “founders” who build a feature that a market leader will inevitably get to—and I use quotes here for a reason—is that they lack vision. The act of selecting a feature as their life’s work, as opposed to a full-blown product or a mission, disqualifies them from being a true founder.

The right answers to “Why are you building this?” tend to be personal. Travis Kalanick and Garrett Camp built Uber because they couldn’t get a cab in Paris at a technology conference. Elon Musk built SpaceX because he wanted a backup plan for humanity.

If you unpack this question, you’re really asking, “Why will this idea succeed now?”

In some ways, “Why now?” is the most important question about the business you can ask because there are so many folks constantly trying the same ideas over and over again in our business. Google was the twelfth search engine. Facebook was the tenth social network. iPad was the twentieth tablet. It’s not who gets there first. It’s who gets there first when the market’s ready.

In meetings with founders, I’m often able to tell them exactly how much money they are burning and when they will be out of cash. It’s fairly easy to do: you simply write down what their revenue is and how many full-time employees they have.

You need to figure out the avg employer cost per FTE. Add €10K for misc spend, subtract monthly revenue and you can pretty much calculate monthly burn. Ask how much they’ve raised and when. You can calculate from that how much cash and runway they should have left. And from the revenue growth rate, when they should be profitable.

There is nothing more bonding between two people in my experience than talking about how you grew up. Sometimes this question will turn into a wonderful twenty-minute detour and you’ll hear that someone is from a blue-collar background and their parents worked as nurses and janitors to put them through an Ivy League school. Other times, people might talk about their mother dying when they were ten years old. The reason I like to ask this question is because it bonds me with the founder. What a founder’s parents think of their path is critical, almost as critical as what the founders themselves think of their chosen path.

Everyone wants to be a founder, but they don’t understand exactly what that means. Being the leader sucks because you’re ultimately responsible not only for your performance but also for the performance of your entire team, the market, your investors, your competitors, and even your customers. Most people calling themselves founders today are just playing the role of founder—whether they know it or not.

What you need to figure out is if this founder will quit when things get hard. Anyone can come to work if there is three million in the bank, people are getting paid top salaries, and you have free food.

The number one reason a startup shuts down is not actually running out of money, which is what most people believe. The number one reason a startup fails is that the founder gives up.