In our previous post, we discussed the strategies you can employ to increase your chances of being successful at investing in startup businesses by mitigating small business risk. In this post, we will address the other major risk inherent in Angel investing – liquidity risk – and ways you can mitigate liquidity risk, as well. For a refresher on the risks, you can revisit the “Is Angel Investing Risky?” post.
Because there is no readily available market to sell your shares in startup companies, your money may be tied up for several years before you see any returns (liquidity risk), and there is a chance that you will not get back any money at all.
This will also sound obvious, but you will only want to invest money you will not need access to in the short-term, or for that matter, that you can afford to lose. You may need it for a new car or for repairs to your house, school tuition for the kids, etc.
This is more of a tip than strategy, but the point is clear – be sure you can get along without the money in the short-term before investing. To help with this tip, determine ahead of time the amount of money you are willing to devote to investing in startups each year – an amount you are comfortable putting at risk - and stick to that amount when you invest.
Tip #1: Determine the amount of money you want to devote to Angel investing ahead of time and stick to that amount.
Another strategy you can use to mitigate liquidity risk is similar to strategies for reducing small business risk – ask yourself, based on the information the companies provide, if they have a good exit strategy. Did they state somewhere in their business plan when and how they plan to exit or sell their company, or when and how they plan to make distributions to investors, if any? That is when you would get your money back, so it would be helpful to know how and when the business plans to deliver it.
As an example, if Johnny says that he wants to buy and plant apple seeds in his back yard and eventually build a large enough farm to be able to sell apples to every grocery store in the country by the year 2065, you may be waiting over 50 years before Johnny decides to sell and, therefore, to get your money. You will be more likely to succeed if you are able to find companies that clearly define when and how they plan to exit or make cash distributions to investors.
Strategy #8: Does the company have a good and clearly defined exit strategy or a plan to distribute cash to investors?
To help you keep all of this fresh in your mind, here is a quick cheat-sheet for you to refer to before you start making your investments.