The Angel’s Ruin

Below is the “Tip of the Week” transcript from the Podcast Episode 20: non-Unicorn Investing

During the interview today, we talked about the gambler’s ruin… where when there is a positive expected value for each bet, you can still go broke if your bet size is too big. Recall that to avoid the “Gambler’s Ruin” Jerry advocated to:

  1. Keep a standard investment amount, regardless of how much you love the company
  2. Use your pro-rata right on your winners. You have better information than outside investors and should know whether a follow-on investment is a good or bad decision
  3. Establish an investment size that is small enough to build a portfolio. Some say you need at least 10 investments b/c one in 10 is a big success. Others propose a portfolio of 20, which should provide an even better opportunity to hit on a big success. And today Jerry suggested a portfolio size of 30 investments. Whatever the magic number, a portfolio is a must.
  4. Abandon betting strategies that are no-longer working. If you have a thesis and a sector focus, it should be based on external drivers or themes in the greater marketplace. Things evolve and these drivers change over time. One must adapt their thesis and/or sector as the world around them changes.

Not following these tenets and falling victim to The Angel’s Ruin is a common trap for many angels. Varying their investment size, ignoring pro-rata, building a portfolio of very few investments and investing in trends that have run their course are a frequent occurence. I, myself, have made some of these mistakes and fortunately have learned a great deal by doing.

As I take a step back here and consider Jerry’s thoughts on investing, I’m reminded of e-mails I’ve received from some of you. I did a recap episode a few weeks ago and while I’m glad that it was well received, I’ve also heard from others that they’d like a more structured guide on best practices. While my intent has been to cover a range of startup investing topics in the interviews, I do recognize that an organized set of key learnings and principles from the experts, like the lessons of the gambler’s ruin, would be helpful to investors and to those startups that are looking for investment. Fortunately, I have been discussing these principles with many practitioners for the past year and have been compiling these lessons over time. So look out for a release on the website in the coming weeks that will organize these items and help angels leverage the knowledge of the experts to evaluate startups more quickly and effectively and also allow startups to better understand the key elements to help them get funded.

So, to wrap up this tip of the week… consider the Angel’s Ruin as you develop an investment strategy. Assuming an overall target return of 20% on your investments… how many coin flips do you want for a shot at that return?